I will discuss accounting for closed stores in this post. I chose this topic because one of the companies that I used to work for operates through a network of retail stores across the U.S. These retail stores sell products directly to customers. When I first began with the company, I was assigned two states to manage. It means that I was responsible for the accounting of all the properties in those two states.
I remember there was one store that was shut down in the month that I joined the company. Even though the store was ended, its lease would not expire until two years later. I needed to prepare a journal entry (JE) to account for that closed store. Still, I did not know how to do it. I had never done any JE like that in my previous jobs. Like everybody else would do, I turned to Google for help. However, to my surprise, there was nothing useful that I could find about accounting for closed stores with an active lease. As a result, it took me a lot of time to figure out how to do the entry myself. For this reason, I wanted to share in this post how to account for closed stores before their lease ends.
Overview of Accounting for Closed Stores with An Active Lease
For simplicity’s sake, let’s consider this example. There is a property called “Store Dao,” which is owned by Tuong (me). I am the owner and the accountant of the store. In addition, this property is closed in July 2020, but the lease will not expire until December 2021. Under U.S. GAAP, I need to accrue for all expenses that will continue to exist under the store’s contract for its remaining term without any economic benefit to my property. These costs include base rent, property tax, utilities, insurance, etc. My job is to estimate the total of the costs and accrue for that total amount.
If you have been following my website, you know that I got my Master’s degree from Cal State Fullerton. During my time there, I learned about this subject, accounting for closed stores, in one of my accounting classes. Nonetheless, I did not understand the concept at that time due to my lack of experience. When I got chances to do this entry at work, I recalled the knowledge that I acquired from school, and everything started to make sense to me.
Accounting for Closed Stores: Journal Entry to Accrue for Closure Expenses
After I estimate all the costs that can exist after my property is closed, I go on and book a reserve to recognize the costs and make a reservation. This is an essential entry in accounting for closed stores. It is noteworthy that because these costs will become extraordinary costs after my store stops operating, they go to an expense account that is excluded from the EBITDA calculation. Accounts like this are called “below-the-line” accounts. If the estimated total expense is $100000, the JE for this accrual is debiting a below-the-line account for $100000 and crediting a liability reserve account for $100000, which is a liability account.
Journal Entry to Reverse Actual Expenses Incurred
In the following months, when actual costs are incurred, the charges will be credited against the reserve account. Let’s assume that in August 2020, base rent is $2000, and utilities are $100. The entry that I need to create is debiting the reserve account for $2100, crediting utility expense account for $100, and crediting rent expense for $2000. This JE will be monthly until the lease ends.
Journal Entries for Late Accrual of Closure Expenses
Now let’s pretend that I am negligent and forget to book this accrual JE until December 2020. Negligence is unavoidable, not just in accounting for closed stores, but in anything! The entry that I need to prepare in December 2020 will be a bit more complicated. Actually, there are separate entries that should be created. Let’s say the total of actual costs incurred in the period from June 2020 to December 2020 is $15000, including $10000 rent, $3000 insurance, and $1000 utilities. My estimation of the expenses from December 2020 until the expiration date is $70000. The JE will be crediting rent expense for $10000, crediting insurance for $3000, crediting utilities for $1000, and debiting a below-the-line account for $15000. As can be seen, because these costs are real, not estimated, they are reclassified to the below-the-line account, not the reserve account.
The second JE is to recognize the estimated expenses for the remaining term of the contract. It is debiting the below-the-line account for $70000 and crediting the reserve account for $70000.
Journal Entry for Lease Buyout
The last situation that I can think of is lease buyouts. Let’s assume I successfully negotiate a lease buyout of $60000 to get out of the lease. I pay for the buyout in July 2020. The JE is crediting rent expense for $60000, debiting the reserve account for $100000, and crediting the below-the-line account for $40000.
That is all about the accounting for closed stores with an active lease. I think this kind of journal entries are common in businesses where there are many retail stores. Companies usually close stores that are not making a profit to reduce costs. They then use that money to open new stores in new locations. If you encounter this situation and need to book accrual entries for your closed properties, this post is for you. I hope you find it helpful. Happy reading!!!
Bank reconciliations are one of the monthly tasks that any accountants have to do. I find it funny that bank reconciliations are necessary, but accounting students never get a chance to learn about it in school, at least in my case. During my undergraduate studies in Vietnam, because my major was business administration, I only took two accounting classes: Principles of Accounting and Managerial Accounting. In those two classes, I learned about a variety of fundamental accounting concepts such as general ledger, journal entries, chart of accounts, etc. However, the bank reconciliation concept was not one of them. The same thing happened in the course of my master’s studies at Cal State Fullerton. I acquired a lot of knowledge about subjects like differences between U.S. GAAP and IFRS, profit centers, cost accounting, transfer pricing, etc. But there was nothing about bank reconciliations. The lack of practical knowledge that I attained from my education was the reason why I was a bit struggled in my first accounting job. I did not know how to perform bank reconciliations properly.
Nonetheless, after a while, I got used to the reconciliation process and became more comfortable when doing it. Even though it is much easier for me to reconcile bank accounts, I still encounter some difficulties from time to time. I will share some of the challenges that I have faced in this post. I think it would be useful for people who want to pursue a career in accounting or want to know what it is like to be an accountant.
Large Volumes of Cash-Related Transactions
For any business, many daily transactions affect cash. Some typical examples are paying vendors, selling goods to customers, borrowing money from banks, etc. The bigger a business is, the bigger the daily transaction volumes are, and the harder it is to carry out bank reconciliations. In my first job, on average, there were thousands of cash-related transactions every month. Nevertheless, the accounting department reconciled bank accounts only once a month at month-ends. I was responsible for doing bank reconciliations for several months. It took me several days to reconcile one bank account every month. And there were seven bank accounts in total. During the time I was handling the bank reconciliation tasks, Deloitte was auditing the company. The auditors pointed out that my company should perform account reconciliations weekly, considering a large number of daily transactions for better internal control.
Cooperation with Other Departments
Even though accountants are ultimately responsible for doing bank reconciliations, the reconciliation process is still a team effort. The main job of accountants is to identify the reasons for any discrepancies between bank balance and book balance. After pinpointing the causes, accountants need to work with departments from which the problems were originated. The difficulty here is that for other departments, they have their own schedules and tasks. Besides, they may not understand the bank reconciliation process that well. If they are busy, they may not be willing to cooperate with accountants to solve reconciling problems. For instance, in my third accounting position, I was in charge of doing bank reconciliations for around thirty apartment communities that were assigned to me. The on-site managers of those properties were responsible for posting residents’ rent payments. However, there were occasions when the managers posted cash in the wrong amounts, in the wrong periods, or they did not post the payments at all. As a result, after figuring out the problems, I contacted the on-site managers and asked them to fix the issues on their end. For some managers, I had to explain the situations multiple times for them to understand. Furthermore, the managers did not always fix the problems right away. I often had to wait for weeks and send several reminders to have the issues corrected.
Good Computer Skills
Accountants can do bank reconciliations either in Excel or in their company’s accounting software programs. Performing reconciliations in Excel is usually the case. In my experience, I used Excel most of the time. I used Yardi Voyager (an accounting platform) only two or three times. Under both circumstances, I needed to have excellent computer skills to carry out my tasks effectively. For example, when I did bank reconciliations in Excel, I had to use essential functions like VLOOKUP, SUMIFS, CONCATENATE, IF, AND, OR, etc. to help me throughout the process. I imagine it would be a lot more difficult if I were not good at Excel.
Good Note-Taking Skills or Good Memory
Often time, outstanding reconciling problems cannot be resolved promptly. Some items may remain unsolved for several months before they are addressed. One common reason for this trend is as mentioned above. It takes other departments in the same company a long time to fix the issues on their end. In such cases, accountants need to make high-quality and detailed notes. If accountants do not have good note-taking skills, when they return to the problems in the following months, they may not remember what happened. This situation has occurred to me a lot of times in the past. There was one time when I was lazy to take notes for an outstanding item. I discovered that this error derived from the AP team. Thus, I sent a request to the AP team, asking them to take care of it. After that, I forgot about it. When it was time for me to do the bank reconciliation for the following month, I had no idea why the problem was there. It took me a lot of time to recall what happened. It was also more difficult for me to follow up with the AP team. The AP Manager asked me why I did not touch base with them about this issue sooner. I learned a good lesson that day. To do bank reconciliations properly, an accountant must either have a good memory or great note-taking skills.
Above are the most common challenges that accountants encounter with doing bank reconciliations. I believe there are a lot more, depending on companies’ industries, cultures, and the experience of accountants. I will add more to this post if I can think of anything else.
So far, in my career, there was only one company where I was responsible for booking monthly journal entries to recognize bad debt expenses. I will describe in this post how I booked the bad debt expense entries at that company.
In my previous post, Month-End Closing Process, I mentioned that the Accounts Receivable (AR) Manager needs to run the Aging report after month-end closing and identify any doubtful accounts. These accounts usually have a 30-day or more past due balance or 16-day past due balance of over $500,000. After identifying all the problem accounts, AR Manager will produce a report and send it out to all departments that need it. The accounting department is one of them.
After I receive the report, I do a quick reconciliation between the report balance and the general ledger (GL) balance of Allowance for Bad Debts account. If the report balance is higher than the Allowance account balance, it means there are new customer accounts with bad debts added to the list. I will book a journal entry to recognize the latest liability expense for those customers. The entry debits bad debt expense account and credits allowance for debt debts account.
On the contrary, if the report balance is less than the balance of the Allowance account, two possibilities can happen under this circumstance. The first possibility is some doubtful accounts are deemed uncollectible, and thus are written off. The write-offs are done in the AR sub-ledger. Accounting is not involved in this process. However, I need to remove the written-off accounts in my Allowance for Bad Debts reconciliation. To write off a doubtful account, AR staff creates credit memos, which debit Allowance for Bad Debts account, to apply to open invoices of that questionable account.
For the second possibility, AR was able to collect from the accounts that were previously deemed doubtful. Payments are created and applied to open invoices of those accounts in the AR sub-ledger. Under this possibility, my job is booking a journal entry to credit bad debt expense account and debit Allowance for Bad Debts account. After that, I need to remove the collected accounts from my reconciliation.
In the case where bad debts were previously written off, but then payments were received for those debts, the recovery process is triggered. Similar to the write-off process, the recovery process is done by AR staff as well. Debit memos, which credit Bad Debt Expense account, are created and applied to received payments in AR sub-ledger. The accounting team has no role to play in the recovery process.
Before going into how and why I chose California State University Fullerton (or Cal State Fullerton for short) for my accounting degree, let me provide you with a little bit of my background. Being an accountant was not always my dream. As a matter of fact, I was against the idea of becoming an accountant when I was young. In the past, Vietnamese society had always viewed accountants as a low-wage profession. However, I felt that destiny had decided that I would one day be an accountant. Back when I was in middle school in Vietnam, business schools were among the top-rated. Most of my friends wanted to get into well-known public business schools such as Foreign Trade University, Banking University of Ho Chi Minh City (HCMC), Vietnam National University, etc. I was not an exception. My goal back then was to become a business student. Like everybody else, to achieve my goal, I spent most of my student life studying and getting good grades in school. Because there were not enough business universities to accommodate the education needs of all students, the competition among the students was stiff. It was one of the reasons why Vietnam’s university entrance exam was hard. It was to ensure that only top students could get into universities. The rest of the students had to sign up for career colleges if they wanted to advance their education. Things have been getting a lot easier these days. Numerous new private universities were founded, and many families can afford to send their children abroad for college. Nowadays, the entrance exam is not as hard as it used to be. In my case, I chose Cal State Fullerton after I graduated from my university in Vietnam.
After twelve years of diligent work, I was able to get into one of the best business universities in Vietnam. The school I attended was the University of Economics HCMC. After my college admission, I found out that I did not have any particular career objectives in mind. All I knew was I wanted to be an office worker. It was the sole reason why I chose business administration as my major, which can give me a broad understanding of fundamental business concepts and expose me to all areas of business, such as accounting, finance, marketing, and economics. For all the courses that I took during my undergraduate studies, I enjoyed the ones that involved numbers and calculations the most. In high school, math had always been my favorite subject, and it continued to be so during college. Despite taking only a few courses in accounting, I knew that this was the subject that I wanted to study further. It was the primary motivation for me to pursue a master’s degree in accounting at Cal State Fullerton.
Several factors led me to my decision to choose Cal State Fullerton as my graduate school but not others. First, the U.S. has always been my number one choice when it comes to education. It is undeniable that the American education system has an excellent international reputation. Many American universities are among the top-ranked globally. U.S. degrees are acknowledged around the world. Second, California has the largest economy in the U.S. (Wikipedia). Furthermore, California is one of the most culturally diverse states in the country. Third, I always prefer public universities to private ones. This is a common preference among Vietnamese people. In Vietnam, most public schools have better quality than private schools. Even the worst public schools are considered superior to the best private schools. Consequently, it is much harder to get accepted to public schools. CSU Fullerton belongs to the California State University system, one of the two most significant and most reputable state university systems in California, along with the University of California system. Fourth, CSUF’s accounting program is well known for its high-quality and excellent professors.
Moreover, the accounting program and the business programs at CSUF is accredited by AACSB (dual accreditation). In fact, the business college of CSUF (Mihaylo College) is the largest accredited business school in California and the fifth largest in the U.S., and it is one of five undergraduate business schools in California with accreditation in accounting. In my opinion, the accounting program at CSUF is second only to the one at USC in Southern California. However, USC is much more expensive. CSUF is more affordable, especially to an international student like me, who had to pay out-of-state tuition. Plus, USC is a private school. Finally, CSUF has relatively small class sizes. According to U.S. News Education (2013), Cal State Fullerton students received specialized attention with a 26:1 student-to-faculty ratio and 21.4 percent of Fullerton’s class sizes averaging fewer than 20 students. All these factors make CSUF a great choice for students who want to earn a degree in accounting or business.
In terms of student clubs, the Accounting Society and Beta Alpha Psi (BAP) are the two most popular clubs that accounting students can join. The quality of these two clubs enhanced my positive experience at Cal State Fullerton. I was a member of both clubs the whole time. Not only they helped me get more involved on campus, but they also gave me chances to promote my professional development through their activities and events. Meet the Firms, Mock Interviews, and Office Tours were my three favorite events. They were all beneficial to me. Meet the Firms was the biggest event for the club members because it was held only twice a year, once in the spring semesters, and once in the fall semesters. During this event, I had the opportunity to network with working professionals from local accounting firms. From the conversations with those professionals, I was able to get an idea of how to prepare myself for my future career. I also had good times meeting new people during the Office Tour events, which were held more frequently than Meet the Firms. Each Office Tour offered me a chance to visit a firm’s office. It was good learning exposure to a variety of working environments.
My most memorable event was the pumpkin decorating contest in my last semester. I worked with other members to create a pumpkin masterpiece called “Mihayloween”. Even though we did not win, it was fun for me, and I made a lot of new friends.
To sum up, I was upset that I had to leave CSUF after my graduation. I love the campus and the people there. I think choosing to study at CSUF was one of the best decisions that I have ever made.
With the ongoing coronavirus pandemic, working from home is no longer an option. It is compulsory across the U.S. I am not an exception. I work as a junior staff accountant by a property management company in Irvine, California. My company started asking its employees to work from home at the end of March 2020, following the stay at home order from the Governor of California. The order was issued in an effort to stop the spread of coronavirus. Two months later, I am still working from home in isolation from other people. I enjoyed this work-from-home thing at the start. However, as time went by, the feeling of loneliness grew bigger and more prominent in my mind. I missed my interactions with other colleagues in the office. Regardless of my feelings, I still need to carry out my job and duties daily. To ensure that I can work excellently, I follow a fixed schedule on my workdays. My intention for this post is to share with you some brief overviews and insights into a typical day of a quarantined accountant.
Every day, I woke up at 6:30 am to do personal hygiene. I only have two meals a day, so I usually skip breakfasts. I start working at 7 am. I am provided with access to the Citrix Workspace app. This app allows me to control my work computer from my laptop. I open the Citrix app, enter my credentials, and my work computer’s screen appears in front of me. At work, I am provided with two widescreen monitors. However, at home working as a quarantined accountant, I only have my laptop with a much small screen to work with. It is harder for me to do my job with only one small screen. Still, I can get used to it.
Before I start working, the first thing I do is opening the Outlook app to check my emails. I usually spend around fifteen to twenty minutes on checking my inbox. I have been working for three different companies so far. All of them use Outlook as the main email app. I have grown accustomed to this app to a point where I do not think I would be able to work without it. In fact, Outlook, along with Excel and accounting software programs (Dynamics GP, Yardi, Sage), are three apps that I use day-to-day. Outlook lets me create folders and rules to organize my emails automatically. For me, I create an inbox folder for each person with whom I communicate the most. For instance, I create one rule and one folder for my supervisor’s emails. All emails that my supervisor sends to me will automatically go to that particular folder. Every morning when I check my inbox, I normally check this folder first to see if my supervisor assigns me any tasks to do.
After checking my emails, if there are any urgent tasks, I will take care of those tasks first. For my current job, urgent tasks are generally related to bank activities or audit requests. If there is no urgent task, I will carry out my normal work routine, which begins with checking cash balance. I am assigned a portfolio of over thirty apartment communities. I am responsible for all accounting related matters of those sites, ranging from bookkeeping to producing financial statements. The first thing that I do every day is to make sure all my communities have enough cash for their daily operations. If any of my apartment sites have a low cash balance, I will need to set up a wire transfer to fund that community.
My schedule as a quarantined accountant does not change much. When I am done with checking cash balance, what I do next depends on the time of the month. If it is the beginning of the month, I do month-end closings for the prior month. If it is in the middle of the month, I perform reconciliations for balance sheet accounts. Finally, if the time is near the end of the month, I review rent reports, delinquency reports, and security deposit reports. For month-end closings, my major assignments are booking monthly journal entries, reviewing general ledgers, and creating financial statements. On average, I can complete month-end closings for three properties in one day. I have over thirty properties in my portfolio, so it takes me about ten days to finish them all. By the time I am done with month-end closings for all my properties, it is the middle of the month, which means that I need to start working on the reconciliation tasks.
There are two balance sheet accounts that must be reconciled monthly. They are cash account and resident refund account. For cash account reconciliations, also known as bank reconciliations, it must be done to ensure that cash balances in the accounting system agree with bank balances. If there is any variance, it is my job to figure out why. The variances are mostly due to timing differences. It means the times when transactions are posted in the accounting system are different from the times of transactions posted by the bank. If this is the case, all I need to do is making notes. If a variance is not a timing difference, I usually contact on-site managers or accounts payable department to work with them on solving the variance. For resident refund account reconciliations, my task is to verify that on-site managers properly complete security deposit dispositions and that accounts payable team process refunds for past residents timely and correctly. As you could have guessed, when I finish my reconciliation tasks, it is almost the end of the month. I must start reviewing different reports to prepare for the next month-end closings. As can be seen, the life of an accountant is like a cycle, which repeats itself and never ends. This life gets worse as I am working from home as a quarantined accountant.
Going back to my work schedule, typically, I take thirty-minute lunch breaks. Because I start working at 7 am, I can get off work at around 3:30 pm. It does not matter when I start working. As long as I work for eight hours a day, I am good. I rarely work overtime. This is especially true as I am working as a quarantined accountant. Furthermore, my company has a strict policy regarding working overtime. Technically, I need to get approvals from my supervisor to work overtime. For accountants (and quarantined accountants), the busiest times are when they do month-end and year-end closings. If one needs to work overtime, it has to be for the closings.
It is pretty much it for a typical day of my accounting life as a quarantined accountant, with or without the coronavirus. There is nothing fancy about it. Practically, I do the same things repeatedly every month. If you like working with numbers and doing repetitive tasks all day, accounting is definitely for you.
In this post, I will describe the month-end closing process at one of the companies that I used to work for. Throughout the time that I was there, the company was going through an accounting system transition from PDS to Microsoft Dynamics Great Plains (GP). Thus, it had been using both accounting systems at the same time until the transition was completed. I also wanted to note that I worked for General Ledger (GL) team. Hence, the process described here is from my perspective as an accountant.
Prior to the start of the month-end close, the GL Accounting Manager holds a meeting with the members of the accounting department, as well as members of other various departments that have responsibilities related to the close, to inform the closing dates for each process with a closing calendar. The closing calendar notes critical deadlines, including:
- Close of Accounts Receivable Sub-ledger (Business Day 2)
- Close of Accounts Payable Sub-ledger (Business Day 3)
- Close of Inventory Sub-ledger (Business Day 3)
Close of Accounts Receivable Sub-ledger During Month End Closing
The closing of the Account Receivable (AR) sub-ledgers (PDS and GP) is typically the first step in the closing process. Accounts Receivable is scheduled to close on approximately the second or third working day of the subsequent month. Once the sub-ledgers are closed, invoices cannot be raised for the closed period.
Before closing the sub-ledger, AR Manager compares the balances between the AR Aging and the Trial Balance. Differences noted are usually sales transactions that are approved in the system for the subsequent month, but were recorded in the preliminary AR Aging report for the month that is being closed. As long as sales transactions are recorded in the correct accounting system, there is no need to change anything in the system. After agreeing on the total receivable balances per the sub-ledger reports to the general ledger, the AR manager closes the AR sub-ledgers in both PDS and GP systems.
Following the close of AR, the AR Manager then generates the combined AR Aging report and creates the Problem Accounts Report for accounts that could have potential collection problems. The report contains the following information: account number and name, previous month-end balance, current total, credit limit, provision percentage, and comments. The Comments section is updated by the AR Manager and explains the current status of the outstanding aged balances. Explanations are required for accounts that are 30 days past due and/or 16 days past due with a balance of over $500,000. The AR Manager sends the reports to CFO and Assistant Finance Manager for their review. After the report is approved by the CFO, AR Manager distributes the report via email to all distribution managers. A meeting is held between finance and distribution within the first ten working days of the month to discuss the report. Based on the Problem Accounts Report that AR Manager provides, accountants manually book a journal entry to record estimated bad debt expense and allowance for bad debt. This entry is included in the monthly journal entry checklist maintained by the Accounting Team.
The AR Manager also needs to run the Accounts with Credit Balances Report after AR is closed. The report reflects the customer balances for customers with credit balances at month-end by the aged period, such as current, past 30 days, over 60 days, etc. The report is provided to Accounting via email at month-end for a monthly reclassification entry. The purpose of the entry is to recognize customer credit balances as a current liability as they are money that is owed back to the customer. The total ending balance of the report is credited from the AR general ledger account to the Customer Cash general ledger account (liability).
Close of Accounts Payable Sub-ledger During Month End Closing
The closing of the Accounts Payable (AP) sub-ledgers (PDS and GP) is the second step in the closing process and is typically scheduled to occur on the third or fourth day of the subsequent month, depending on invoice volumes. After AP is closed, vendor invoices cannot be recorded for the closed period. Any invoices that come subsequent to the close of AP, but relate to services rendered in the closed month, will need to be accrued for by the General Ledger team through a series of accrual journal entries.
The AP Supervisor is in charge of closing the sub-ledgers in both the PDS and GP systems. Prior to closing AP, the AP Supervisor ensures that all vendor invoices pertaining to the period being closed have been recorded in the AP module and that all cash applications have been processed in both accounting systems. Selling, General and Administrative (SG&A) expenses, and employee expense reimbursement reports should be submitted in time to the AP department so that they can be processed in the correct period.
Close of Inventory Sub-ledger During Month End Closing
The close of the Inventory sub-ledger is the third step in the closing process and should be done in conjunction with the closing of Accounts Payable. The inventory team should ensure all sales are entered prior to the month-end. At month-end, Inventory Analysts are responsible for reconciling the inventory per the sub-ledger (Product Transaction Report) and the general ledger. Any differences noted on the reconciliation are researched, resolved, and documented within a journal entry to adjust for the differences. The journal entry and supporting documentation are provided to the Controller for review and approval. Differences are typically attributed to the wrong coding of inventory in the general ledger, or variances noted between “on hand” and “available” quantities in GP. For the former, reclassification entries within the respective inventory accounts are recorded.
Preparation of Journal Entries
A standard journal entry checklist is utilized by Accounting to ensure all recurring manual journal entries required during the financial close are posted. The checklist includes information such as journal entry reference, description, frequency, system (GP or PDS), timing (i.e., dependencies: before/after month-end, after AR close, after AP close, etc.), due date, and mode (standard/reversal).
Journal entries are organized by the department responsible for the preparation and approval of the entries. Entries are referenced by seven different categories: SG&A, Sales, Tax, Inventory, Risk, Compliance, and Final. Accounting is responsible for preparing SG&A, Sales, and Final entries. Preparation and approval of Tax, Inventory, Risk, and Compliance entries are the responsibility of the corresponding departments. However, members of the Accounting team are the only personnel who are permitted to post to the general ledger and thus are responsible for posting all entries.
All manual accounting entries require an independent review, and both preparers’ and reviewers’ names are entered on the journal entries checklist. Entries are approved manually outside the system via email. The entries are due between the last day of the month or the first day of the close and the eighth business day of the close. After the journal entries are approved, the General Ledger team is responsible for uploading the journal entries to the systems. Journal entries should be booked at the earliest possible date in accordance with their dependencies if any. Journal entries are assigned a specific due date based on the close schedule.
Consolidation and Financial Reporting
After all the manual journal entries are posted for the month, Accounting will post two final journal entries to transfer the PDS trial balance to Great Plains. After consolidating the data, the GL Accounting Manager will perform a P&L to GP Mapping as a final check for accuracy. An adjusting entry will be made if necessary, to ensure that the control accounts that should have a zero balance are zero.
In addition, during the consolidating process, Accounting is required to prepare elimination entries to remove inter-company transactions between my former company and its wholly-owned subsidiary, which is a logistics trucking company. The subsidiary’s financials are consolidated into my old company’s financial statements.
After all consolidation journal entries are booked, the Accounting Manager will prepare financial reports by downloading the financial data from the Great Plains system and creating an Excel worksheet. Several versions of the financials will be drafted before the final numbers are confirmed by the Controller, Accounting Manager, Risk Manager, and CFO. Once the month-end financial numbers are approved, the Accounting Manager runs the final trial balance and save the final version of the financials to a month-end folder on the company shared drive.
Accrual basis and cash basis are the most fundamental concepts of accounting. Students, who major in business administration or accounting, often learn these definitions on the first days in their accounting classes. When I first learned about these two methods in my accounting classes in college, I thought that a business could only follow either a cash structure or an accrual structure. It cannot pursue the two methods at the same time. However, after working for different companies that implement both, I got that a company that is under cash accounting can still use an accrual method. In this post, I will go over and discuss the accrual basis in those cash-based companies, as well as the differences between cash-based and accrual-based companies regarding accrual procedures.
Accounts Receivable and Accounts Payable
For businesses that follow a cash-based model, they still need to use some accrual ideas, such as accounts receivable and accounts payable. It is a common knowledge that accounts receivable allows a company to recognize revenues even if it has not yet received any cash, and accounts payable enables the company to recognize expenses even if it has not yet paid out any money. This approach of accrual basis is completely opposite from the cash-based approach, which states that costs and revenues can only be recognized when there is cash involved.
The reason why cash-based businesses must use accounts receivable and accounts payable is because of accounting software programs they use. In these programs, accounts receivable and accounts payable are the two default modules, along with the general ledger module. Sales invoices are raised in the accounts receivable module, and vendor invoices are created in the accounts payable module. I cannot imagine an accounting software solution that does not have these modules for recording sales and payment activities. I guess due to the dominance of accrual-based businesses, most of the accounting programs in the market are designed for an accrual basis.
For example, when a bookkeeper creates a sales invoice in the accounting system of his or her company, revenue is immediately recognized and accounts receivable balance increases. The accounting system cannot tell and does not care whether the company follows a cash basis or an accrual basis. The accountant must adjust the general ledger and financial statements to reflect the cash nature of his or her business. In this particular example, the bookkeeper can book a monthly temporary journal entry to remove the accounts receivable balance from the total revenue.
Similarly, the accountant can book another monthly temporary entry to deduct the payable balance from the company’s total cost. Alternatively, the company can issue payments to all vendors as soon as invoices are entered into the accounting system. By doing this way, the accounts payable balance is always zero. Thus, it will not have any impact on the income statement.
Differences in Accrual Journal Entries between Accrual Basis and Cash Basis
For cash-based organizations, they sill prepare accrual for revenues and expenses to some extent, especially when they need to submit their financial reports to external stakeholders. However, the frequency of accruals in cash-based entities is much less than that of accrual-based firms. For instance, I used to work for a cash-based company in Irvine. This company did not accrue for any revenues or expenses until the year-end closing. In contrast, for other accrual-based companies that I used to work for, they book accrual journal entries monthly during month-end closings. The second difference is the method of accrual. In cash-based companies, their accruals are built on the numbers of months. Meanwhile, in companies that are on an accrual basis, their accruals are based on the service periods.
To illustrate this point, let’s go back to my former cash-based employer. I still remember every time I submitted my year-end accrual entries to my supervisor at that company; he always checked my work by looking at the trend report and counting the number of months. If there were any expenses incurred in less than twelve months, my supervisor would ask me to accrue for the average amount multiplied by the number of missing months. For example, if electricity expenses were paid only ten times in that year, my boss would ask me to accrue for two more months. The bottom line is that I needed to ensure that all revenues and expenses were twelve months’ worth. For the accruals in my other companies that follow accrual basis, the service periods of a cost or revenue is more critical. For example, if I am doing month-end accruals for July 2020, any invoices that have the service period pertaining to July 2020 will need to be accrued for.
The third and final difference is that cash-based companies accrue for only certain expenses and revenues, especially if they are recurring (e.g., utilities, maintenance costs). Accrual-based companies, on the other hand, accrue for almost all of the profit and loss (P&L) accounts. As a result, the accrual tasks in accrual-based companies are much heavier than the accruals in cash-based companies.
What I have mentioned in this post is the main differences between accrual-based companies and cash-based companies. As can be seen, contrary to the public belief, companies that follow a cash basis still carries out a few accrual projects. Nonetheless, the frequency, the number of accounts involved, and the method of accruing is much less intense than those in accrual-based firms.
Texas Instruments (TI) and Hewlett-Packard (HP) were two electronics firms that developed, manufactured, and sold electronic products. Although the two firms operated in similar industries, they chose very different management control systems and strategies. While TI’s competitive advantage was mainly based on high volume and low price, HP’s competitive advantage was to manufacture high-value and high-feature products. Given the discrepancies in strategy between the two firms, it is expected that there were also differences between TI and HP in their planning and control systems.
Overview of Texas Instruments and Hewlett-Packard
TI had three main lines of business: components, digital products, and government electronics, which generated 46 percent, 19 percent, and 24 percent of the total TI sales, respectively. HP had two main lines of business: computer products contributed 53 percent, and electronic test and management control systems added 37 percent of the total sales.
Financial Information on TI and HP from 1980 to 1984
When turning to the old financial data from 1980 to 1984, the sales of TI over the years tended to be increasing slowly, compared with the sales of HP, which were rising rapidly. Specifically, TI has an average 9.327% growth rate, while the average increase rate for HP was 18.3848%. HP sales in 1980 were around $3 billion but increased to over $6 billion in 1984. On the contrary, sales of TI were about $4 billion in 1980 and went up to $5.7 billion in 1984. As a result, the revenue of HP was higher than that of TI in 1984, although it was generally lower in previous years.
Historical Stock Price Values of TI and HP
The following chart illustrates the fluctuation of stock prices of TI and HP from January 1980 to March 2016. The two company’s stock prices follow the same pattern as TI and HP are in the same industry. Their stock prices are influenced by the market. However, HP’s stock prices fluctuate more than that of TI.
The reason for the difference in stock price fluctuation between the two companies can be explained by analyzing TI and HP’s business strategies. TI operates in standard markets based on long-run cost position. In contrast, HP seeks high-value, unique, and small product markets. In other words, TI is a risk-averse company, and HP seems to be a risk-taker. Higher risk leads to greater fluctuation in stock prices of HP. The company is more profitable in a booming economy, and take a more significant loss during recessions.
Organizational Structure and Management Control Systems
On the one hand, both TI and HP used related diversification, as their primary business lines were involved in a similar specific industry. First, each business line in both companies is treated as an independent business unit. Nevertheless, there was a high degree of interdependence among the business units. For example, for TI, products in components line can be used by the government electronics line. Similarly, electronic test and management control systems can be applied to the process of computer products to evaluate whether the computer products met HP’s standards. A related diversified firm’s core competencies decide the strategy of all the business units.
On the other hand, although both TI and HP operated in the same industry, and adopted related-diversification strategy, their target markets are materially different. TI targeted large, standard markets, while HP concentrated on selected small markets that favor high-value/high features products. The difference in target market choice between the two companies leads to a difference in the internal business structure. TI was similar to a conglomerate company, which operates in a single industry. HP was more like a related-diversified company. The width of the market decides the width of the product lines.
Business Unit Identification
Diversified corporations segment into business units. The missions of the business units can be classified as “build,” “hold,” or “harvest.” The purpose influences the uncertainties that the business units have to face, the short-term and long-term trade-offs, and the design of related management control systems. Business units of HP tended to suffer more considerable environmental uncertainty as they managed to create new markets, resulting in a “build” strategy for short-term profit trade-off. TI, however, wanted to maximize its market shares in the mature stage of the product life cycle, took a “harvest” strategy.
Functional Strategy Overview
Marketing: Because TI pursued a long-term and low-cost position, its products were sold in high volume at a low price. In contrast, HP’s products had high value and were sold at a high price.
Manufacturing: TI obtained its cost advantages by applying economies of scale and learning curve. TI also manufactured its products through vertical integration and in great and low-cost locations. Because TI used economies of scale, the company had higher fixed costs. When the economy is in a boom, HP will be more likely to perform well. However, when the economy is in a recession, HP will be more vulnerable. HP, on the other hand, concentrated on delivery and quality-driven products that were manufactured in small and attractive locations through limited vertical integration.
R&D: R&D activities at HP focused on process and product and were driven by cost. HI’s R&D activities focused on products only and were inspired by features and quality.
Financial: While TI relied heavily on debt to finance its business, HP used more equity and no liability in its financial structure. TI would be more vulnerable to market conditions than HP.
Management Control Systems and Strategies of TI and HP
Mission: TI’s mission was to “harvest,” while HP’s mission was to “build.”
Business Strategy: TI pursued a long-term and low-cost position in large, standard markets to create a competitive advantage. On the contrary, HP produced unique, high-value, high-feature products for selected small markets to create a competitive advantage.
Product Life Cycle: TI entered its markets early. When the products matured, the company managed to have dominant market shares. HP, on the other hand, created new markets. When the markets developed, and other cost-driven competitors entered, the company exited its markets. In both companies, the entry-stage accounted for most of the product life cycle. The introduction stage could be the most expensive when launching a new product. The size of the market for the new product is small, which means sales are low, although they will be increasing. TI entered its markets early to look for cost-leader positions, while HP created new markets to be the market leader. Both of them needed to devote a lot of time in the early stage. However, the difference was that TI’s maturity stage was longer than its growth stage. It was the opposite of HP. Again, because TI was pursuing market leader positions, the more prolonged maturity stage indicated that the company successfully achieved leading positions. Concerning HP, whose products were typically high-value and high-feature, the longer the growth stage, the more effort it put in its products.
Costs and Prices (Learning Curve): TI focused on price cuts, cost reductions, and high volume to take advantage of shared experience and learning, while HP focused less on cost reductions, but more on ROI and profit margins by holding prices longer during the initial periods. TI’s strategy in manufacturing is scale economies; by making use of the skills and technology, the unit cost decreased, which benefits to the market in a lower sales price. In return, TI benefited from higher market shares. TI’s strategy resulted in penetration pricing, which was used to secure market shares. On the contrary, HP’s plan was to create new markets and exit when they matured. This strategy led to skimming pricing, which was used to maximize profit in the early stage of the product life cycle.
Product Process Matrix: Different target markets determined the differences in the product-process matrix. TI paid attention to capital-intensive and cost-effective production processes to meet the needs of its standard and high-volume markets. Conversely, HP paid attention to flexible production processes to meet the needs of its custom and low-volume markets.
Portfolio Analysis: TI used cash from current “cash cows” (low-growth business with dominant market shares) to develop its “question marks” (high-growth companies with low market shares) into new “cash cows.” HP only focused on “stars” (high-growth businesses with dominant market shares). “Stars” often used up large amounts of cash because of their high growth rate. As a result, major resources were reallocated solely to fund new businesses.
The strategies that TI and HP implemented were significantly different. Furthermore, the missions of the corporation and business units of each company were various. The analysis below focuses on the planning and management control systems of the two companies, based on their corporation and business identification.
Strategic Planning Systems of TI and HP
The differences in corporate strategies determine the differences in management control systems.
A single-industry firm, like TI, is more likely to take “harvest” strategies. It has a lower level of interdependencies among business units, but higher certainty due to the mature market it chose to stay. The senior managers at TI may not have significant knowledge or experience in the operation of various business units.
In contrast, a related-diversified firm, like HP, tends to take “build” strategies. It has not only a higher level of interdependencies but higher uncertainty due to new products in new markets. The management of HP may have more knowledge of activities across various business units. HP may require smoother and more effective communication channels across business units.
TI’s business units have fewer similarities in products’ features, manufacturing processes, and marketing strategies. The lower level of interdependency among business units and less specialized knowledge of management determines that TI adopts a vertical management control system. Business units prepare their strategic plans and submit them to senior management to approve.
In contrast, HP can use both vertical and horizontal management control systems. The horizontal dimension might be incorporated into the management control system in different ways. For instance, HP can develop a sub-strategic plan for a unit group that explicitly identifies synergies across individual business units.
Importance of Strategic Planning
HP seeks to create a new market and operates in a rapidly changing environment. The higher uncertainty of the environment requires that HP pays more attention to its strategic planning.
Conversely, TI prefers long-term operation in mature markets, so it tends to operate in a relatively stable environment. Therefore, the importance of strategic planning is lower correspondingly, and a broad-brush strategic plan may be enough to control the business operation.
Capital Investment Evaluation
TI’s investment decisions rely more on quantitative, financial, and formal information because TI operates in mature industries. It has more financial information available in its markets and can easily collect useful data for project analysis. TI emphasizes more on formal discounted cash flows analysis because the stable environment allows TI to predict future cash flows accurately. Besides, a mature industry does not offer tremendously new investment possibilities; hence the required rate of return may be relatively high in order to motivate managers to search for projects with exceptional performances.
In contrast, HP’s investment decisions rely more on non-financial and informal data because of the uncertainty in the growth stage of its markets. The financial analysis of HP’s projects may be unreliable due to the unpredictability of the future phase of the markets. Also, HP may set a lower required return rate to motivate the managers to come up with new investment ideas and management control systems.
Management Control Systems and Budgeting Systems of TI and HP
The Role of Budget
As the cost leader, and harvest strategy taker, the budget was a control tool for TI. For HP, the budget was more like a short-term planning tool.
HP concentrated more on flexible production processes to meet the needs of its customers and low-volume markets. Therefore, it relied on high control limit in periodic evaluation against budget. The budget can change every year as the markets change. The greater the uncertainty, the more difficult it is for management to regard subordinates’ budget as firm commitments, and use the variance to evaluate the performance. As a result, the budget is not that important to HP. However, TI concentrated more on capital-intensive and cost-effective production processes to supply to its standard, high-volume markets. TI’s target markets are less flexible compared to HP’s. As a result, comparing budgeted and actual results to identify favorable or unfavorable variances can determine whether the performance is efficient. Meeting estimated numbers is significantly crucial to TI’s business model.
As TI was pursuing long-term cost positions in standard markets, it preferred to enter the markets early, then expand quickly to strengthen its cost-leading positions. TI eventually accounted for dominant market shares. In the marketing function, the budget cost should be based on the length of the product life cycle. The product life cycle is longer in both the entry and mature stages compared with the growth stage. Thus, TI devoted more marketing expense in these two stages, in order to fast entry and then take the market-leadership positions.
However, HP’s strategy is to create new markets by introducing unique, high-value/high- features products. In the early stage, including the development period, the product life cycle was longer than the mature and exited stage. The reason was that to introduce new products, HP spends an extended period on research and development typically. When the technology used in production became mature, the product life cycle would be shorter. At the same time, cost-driven competitors entered the markets, these markets matured, and HP exited the markets. Therefore, the budget focused on research and development to create new markets and control growth. When the market was created, HP would be the market leader, which provided a lot of opportunities for it to earn profits and enhance its management control systems.
Management Control Systems and Budgetary Process
For HP, the process was bottom-up. The build managers, including lower-level managers and employees, had more influence in preparing the budget when responding to the rapid changes in the environment. They had more knowledge of these changes than top management. Moreover, the budget revisions were likely to be more frequent due to the flexible shifts in the environment.
In contrast, the situation was different for TI. As the harvest company, the budgetary process was top-down. TI aimed at long-term market positions; the individual business unit manager had a profound influence on preparing the budget. However, the feedback from the senior management on the variances and management control systems was frequent.
Reporting Systems of TI and HP and Management Control Systems
The differences of reporting control systems between a “build” company and a “harvest” company lie in two points: the frequency of reporting and contacts with superiors, and the form of communication between superiors and subordinates.
Frequency of Reporting and Contacts with Superiors
HP, which is a “build” business, tends to develop new products and explore new markets. HP likely has less experience to cope with the possible management issues in a new product line. Therefore, building new procedures and policies for each of its specified product line becomes the most crucial part of the company’s reporting system. Consequently, HP’s reporting system takes more informal communication forms and focuses more on policy issues and less on operational matters.
In contrast, TI, which is a harvest business, tends to stay in its markets and tries to expand the market shares. Over time, it has accumulated experience and developed mature operating procedures. Therefore, TI’s reporting system takes formal communication forms and mainly focuses on operating issues rather than policy issues.
The Form of Communication between Subordinates and Superiors
For HP, the management may know the firm’s operation intimately. Thus, the top executives may be able to control the activities of subordinates through informal and interpersonal interactions. Therefore, the reporting form mainly relies on everyday communication.
For TI, the management tends to use more formal documents and procedures to control the subordinate business units. The chief executive officer of TI may not have enough expertise to manage the different business units. Thus, he or she has to rely on the formal form of the reporting system.
Performance Evaluation Systems of TI and HP and Management Control Systems
Texas Instruments Balanced Scorecard
|Strategic Goals||Strategic Measures|
|Financial||Maximize profits and cash flow Minimize long-term investments, focus on short-term profits||Product line and customer profitability Unprofitable customers and product lines|
|Customer||Align sales and productions Sell quality products to customers||Backorders Sales bookings|
|Internal Business||Maximize capacity utilization Avoid keeping excess inventory to reduce cost||Capacity utilization rate Inventory turnover rate|
|Innovation and Learning||Improve technology to reduce costs Improve production processes and products||Cost reduction rate Cycle time|
Financial perspective: Because the markets that TI has entered no longer guarantee a significant return on investment. The profits from these markets are used to maintain equipment and capabilities and invest in new potential markets, any investment made by TI in those markets needs to be short-term and can maximize cash flows back to the company. Therefore, the financial goals of TI emphasize cash pay-back and not future return on R&D activities.
Customer perspective: To reduce costs and measure customer satisfaction, TI uses backorders to measure the imbalance between sales and production. Besides, TI can predict its sales revenues by measuring sales orders booked.
Internal business perspective: In order to keep its costs low, TI needs to control its capacity utilization and inventory level. Capacity utilization rate and inventory turnover can be useful measures.
Innovation and learning perspective: R&D activities of TI mainly focus on process innovation and cost reduction. These goals can be measured by cost reduction rate and cycle time.
Hewlett-Packard Balanced Scorecard
|Strategic Goals||Strategic Measures|
|Financial||Offer high-quality, high-feature products to customers Create new markets||The sales growth rate in new markets Return on Assets, Return on Investment|
|Customer||Sell multiple products to the same customers New customers||Customer retention rate Customer satisfaction index Customer loyalty survey Percentage of new customers|
|Internal Business||Understand customers’ needs Retain talented and creative employees||Product development cycle Employee retention rate|
|Innovation and Learning||Create innovative products||Percentage of sales from new products|
Financial perspective: Because HP implements a build strategy, the company focuses on building and expanding new markets, offering new products. For that reason, HP uses the sales growth rate in new markets as a performance measure. In addition, HP also pays attention to how much return new products have generated in exchange for the capital that HP invested in creating those products.
Customer perspective: New products that HP creates must satisfy the demands of existing customers and attract new ones. Selling multiple products to the same customers and attracting new customers are the company’s goals. Some measures can be used to assess these goals, such as customer loyalty, customer satisfaction, etc.
Internal business perspective: HP needs to retain its skillful employees to introduce new products and build new markets continually. Employee retention is a useful measure to evaluate how well HP does in keeping its employees. Also, HP’s new products need to meet their customers’ needs. The product development cycle helps assess how well HP understands its customers.
Innovation and learning perspective: R&D projects of HP concentrates on creating new products. This goal can be measured by the percentage of sales from new products.
Incentive and Compensation Systems of TI and HP and Management Control Systems
Percent of compensation as a bonus: TI’s business model is relatively safe. This results in a lower proportion of the payment in bonuses compared to salary. On the contrary, HP’s business model is relatively risky. Hence, HP’s management has a higher percentage of their payment in the form of an incentive bonus.
Bonus criteria: TI’s objectives are more short-term, concrete, and easy to measure. The company aims to reduce its costs and increase its market shares. Thus, the company’s bonus criteria concentrate more on financial benchmarks. HP’s objectives, on the other hand, are more long-term, abstract, and difficult to measure. The company produces high-value and high-feature products for selected markets. Therefore, the company’s bonus criteria emphasize more on non-financial criteria.
Bonus determination approach: Because TI emphasizes more on financial criteria, the company’s bonus determination approach is more formula-based. In contrast, HP’s determination approach is more subjective as HP’s management focuses more on the long run.
Frequency of bonus payment: TI’s bonus payment is more frequent because the company wants to motivate its management to focus on short-term performance. Conversely, HP’s payment is less regular because its managers concentrate more on the long run.
Compensation mix: TI should include more restricted stock awards than option awards. There are two reasons for this. First, the markets that TI entered are stable; thus, the company has less risk exposure. Second, option awards can lower profits because the SEC requires companies to treat stock options as expenses. In contrast, because HP’s strategy is to create new markets, the company is exposed to a lot of risks. To motivate managers to take more risk, HP should increase stock options in long-term compensation.
Conclusion about Management Control Systems between HP and TI
TI’s strategy was to manufacture low-cost and high-volume products. Therefore, its approach was similar to that of a “harvest” company. On the contrary, HP planned to create new markets and exit when they matured. This strategy was similar to the approach of a “build” company. The planning and management control systems of TI and HP were directly linked to their strategies. Generally, “harvest” companies face less environmental uncertainty than “build” companies. Thus, the strategic planning process is significantly more important to HP, which is a “build” company, compared to TI, which is a “harvest” company.
Furthermore, the greater the uncertainty, the harder it is for management of HP to use unfavorable budget variances as transparent measures of poor performance. Finally, in terms of the incentive compensation system, for “build” companies such as HP, because it has a riskier strategy, the proportion of management’s compensation in bonus is higher than that of a “harvest” company like TI. Overall, the planning and management control systems at TI and HP are designed with respect to each company’s external environment, technology, strategy, and organizational structure.
To understand subculture marketing, it is essential to understand the meaning of subculture. Generally speaking, subculture can be defined as a distinct cultural group that exists within a society or a dominant culture. Members of a subculture have different beliefs, perceptions, and values from other members of the same community. A few examples of subcultural groups can be northerners, southerners, elderly, religious groups, geographic regions, etc. Because of the differences between subcultures and the leading society, there are differences in consumption patterns. Thus, marketers can target different products for different subcultural groups. For example, immigrants in the U.S. come from different cultural backgrounds. Consequently, they retain the same consumer behavior, pride, and tradition from their birth countries.
Furthermore, the existence of subcultures gives companies target markets that they can develop. Roughly eighty percent of people will most likely buy a product if a friend or family member refers to them. It means that community value is more important than what businesses tell their consumers. As can be seen, the impact of subcultures on marketing strategies and consumer behavior is significant. This post attempts to understand the role of subcultures in marketing, especially religious subcultures, and geographic regions.
The Influence of Subcultures on Unique Marketing Aspects and Consumer Behaviors
Cultures affect consumer behavior through the unthinking and spontaneous manner of consumers. For example, when a person drives past a billboard, that person does not have enough time to process that billboard thoroughly. Instead, the person’s opinion on the advertisement is likely to be influenced by his or her culture. In the experiment conducted by the author, people are divided into two groups by their cultures: Anglo Americans and Asian Americans. The two cultural groups are then shown two commercials by Welch, which is a famous grape juice producer.
The first commercial is promotional, which focuses on the benefits of drinking Welch’s grape juices (e.g., increase energy level). The second commercial concentrates on the preventive effect of drinking Welch’s grape juices (e.g., reduce risks of certain types of cancer). The result is that Asian Americans prefer the preventive commercial while Anglo Americans favor the promotional ad. However, when asked to examine the two ads more carefully, there is no difference in how the two cultural groups rated the commercials. This outcome indicates that cultures can only affect marketing and consumer behavior on a spontaneous level. Once consumers have time to study more about the products, the influence of religions on marketing decreases.
When a new product is launched, regarding subculture marketing, companies should take into account the influences by cultural differences because consumers have not had time to get to know the products. Their cultures will heavily influence them. For example, consumers in the United States are perceived as immensely individualistic. In other words, Americans make their purchasing decisions based on personal choices. On the other hand, Japanese consumers are inclined to buy and consume products or services, depending on the prosperity of a collective group such as their friends and family. Due to this cultural difference, marketing advertisements that focus on individuals have superior performance in individualistic cultures such as the United States. Likewise, marketing advertisements that concentrate on groups tend to do better in collective countries such as Japan.
An excellent case of how a business can make its product appealing to different cultures is Apple. Apple does not customize its iPhones based on perceptions. This design helps eliminate the two disadvantages described in the previous paragraph. However, people across the globe are still impressed and loyal to iPhones despite their cultural differences. The reason behind this is that Apple offers cultural customizations through customer experience, not through its physical products. For example, Apple’s stores are customized, based on cultures.
In spite of common elements like the Genius Bar, the store experience is designed toward cultural differences. For instance, Apple’s store in Milan, Italy, has an entrance similar to a glass fountain that also serves as a background for the big Amphitheatre. This store helps re-energize a piazza in the heart of Milan. On the contrary, Apple’s store in Paris, France, offers architectural details with marble columns and mosaic floor tiles. This architect is ideal for Parisians’ tastes and cultures. In addition, Apple makes it easy for people to get supports in their languages with local phone numbers and live chat. Furthermore, Apple also tailors its applications towards cultural differences. For example, to enhance Chinese customers’ experience, when updating its GarageBand digital audio software, Apple included Chinese language and musical instruments, such as the Pipa and Erhu.
Advantages and Disadvantages of Being Influenced by Cultural Differences
The most significant advantage of being influenced by cultural differences is that company can reach broader audiences and expand its market. The more cultures companies can reach, the more prominent chances companies can find customers who need their products. One of the disadvantages of being influenced by cultural differences is that companies can quickly lose their unique identity.
For example, McDonald’s is famous for its beef burgers in the United States. However, this reputation on beef burgers does not exist in other countries, such as India, where beef is not accessible. Another disadvantage is that it is hard for companies to control the quality of their products or services across cultures. It is because the products and services are customized built upon perceptions. As a result, the class will vary based on the customization process. Another disadvantage is choosing the wrong cultural markets. It means that the markets are too small, or people in those cultures do not like the products.
Religious Subcultures and Their Implications for Marketing
Religion is one of the most influential and significant parts of the life of most human beings. As a matter of fact, around seventy percent of Americans associate themselves with a religion. Religious subcultures can affect consumer behavior and marketing strategy through four main components: beliefs, rituals, values, and community. In terms of the first component, which is beliefs, different religious subcultures share different views about it. For example, Christians believe in the afterlife while Buddhists share ideas about the permanent self, which is also known as an unchanging soul. Those beliefs may have some influence on specific marketing strategies. For example, previous studies have found that fear of death makes people want to buy more luxury products. However, the beliefs in the afterlife among Christians lower their death anxiety, thus, decreases their desire to purchase luxury products.
Second, rituals can be viewed as religious ceremonies that are performed in the same and prescribed manner or order. Some examples of routines are daily prayers, baptism, meditation, etc. Studies have found that cleansing or purification rituals of past sins or bad behaviors are likely to have an impact on consumer behavior. After those purification rituals, people will change their consumer behavior as an effort to fix their past mistakes and improve their lives. The changes in consumer behavior can be donating, becoming vegetarians, recycling, etc.
For these types of consumers, marketers can increase customer loyalty to their brands by showing how their products are compassionate towards animals and environmentally friendly. Third, religious values provide instructions and directions to believers about what, when, and how much to consume something. For example, Islamic dietary law does not allow its followers to eat pork. Marketers can take advantage of religious dietary restrictions to create a target market for their products by highlighting the fit between their products and customers’ religions. For instance, companies can use words such as “pure” in labeling their products.
The final component is the community. Religious consumers support other members of their religions and assist in satisfying their needs. Members of the religious subculture want to buy products to help preserve their identity and stand out from the rest.
If a company can offer a product that makes members of a religious subculture feel different to the rest and stimulates the development of their subculture, the members of that subculture will be loyal to that company and give the company a great word of mouth marketing that the company can ever have. This is also known as the brand community. When a consumer has become and remained a member of a brand community, that consumer is required to continue using and owning the brand. The brand community, in this case, is the religious subculture. When a consumer starts buying a product because of his or her religion, as long as that consumer remains being a follower of that religion, he or she will continue using the product.
A well-known illustration of how a firm can promote itself among religious communities is Chick-fil-A. The company has implemented robust marketing strategies to boost the company’s image within the Christian community. The company gives out CD’s and toys that contain Christian messages with children’s meals. Chick-fil-A also makes donations to several Christian organizations and charities such as Campus Crusade for Christ (Cru). The most persuasive evidence that shows the support of Chick-fil-A to Christian is to close all Chick-fil-A locations on Sundays, which was explained as a way to honor God.
Geographic Regions as Subcultures and Their Impact on Marketing Strategies
The way that marketers target geographic regions as subcultures in their marketing strategies is known as geographic segmentation. It is viewed as the division of a big market into different smaller markets that consist of customers with similar needs and product requirements. Companies may choose to market their products in one state, but not the others. They prefer to limit their markets to some geographic areas.
Geographic segmentation can have various forms such as the southern region versus the northern part, rural area versus urban area, cold area versus warm area, etc. The purpose of geographic segmentation is to deal with limited resources. Because companies have limited resources, it is impossible to make products that meet the demands of all customers. By choosing the best possible geographic regions to pursue, companies can focus their resources on specific markets to gain competitive advantages and better positions in those markets. The primary marketing strategy for geographic segmentation is product differentiation. It means that companies offer different products to different regions.
A famous example of this type of marketing strategy is McDonald’s. The company offers different versions of its burgers in different countries. For instance, in the U.S., McDonald’s is well-known for its beef burgers. However, in India, McDonald’s does not sell beef burgers. Instead, it focuses on promoting chicken burgers and veggie burgers. In Arabian countries, the company introduced McArabia chicken burgers.
Summary and Conclusions
In today’s business world, it is advantageous for marketers to consider the evolving consumer scenery in terms of culture and subculture differences. This is essential because marketers may try to approach different consumer groups with the same traditional marketing strategies. Marketing customizations based on subcultures can help companies expand their markets and earn customer loyalty. The typical example of marketing customizations is Apple. The company has customized its customer experience based on their cultures and regions.
Similarly, Chick-fil-A has its customization focuses on a specific religious subculture. This customization focus has increased customer loyalty and brand awareness of Chick-fil-A among the religious groups. Even though there are advantages of applying different marketing strategies to different cultures, there are some drawbacks, mostly that companies may lose their identity or choose the wrong target subcultural markets. Because there are advantages and disadvantages, companies should consider the costs and benefits of focusing on different subcultures before they deploy any marketing strategies.
I. Board of Directors
a. Corporate Governance: Board Overview
1. Corporate Governance: Board Elections
According to the firm’s corporate governance guideline, Costco Wholesale Corporation (the “Company”) adopts the staggered board. Directors are divided into three classes; each class is elected to a three-year term. The staggered board prevents any board member from gaining majority control of the board.
Costco’s latest Shareholder Meeting took place on January 29, 2016. The purpose of this Annual Meeting was to elect the four Class II directors, Hamilton E. James, W. Craig Jelinek, John W. Stanton, and Maggie A. Wilderotter, who was nominated by the Board of Directors. All of these four nominees were current directors at the time. Jill S. Ruckelshaus, who was also a current director at the time, decided not to stand for re-election.
Comment: The majority of the Board has served more than ten years. Some of them have been on the Board since its inception. The long tenure of the majority of directors may hurt director independence. One of the reasons is Costco has a staggered board with plurality voting. Even though staggered boards are an effective way to antitakeover, it has negative effects on shareholders’ rights. It is hard for shareholders to vote to replace any board members. Besides, Costco requires supermajority voting (66.67%) when shareholders want to change certain charter provisions. Finally, shareholders cannot take any action in between meetings by written consent. For all of the reasons above, Costco’s shareholders do not have many rights in Costco’s corporate governance.
2. Board Attributes
Compared to eleven members on the Board of an average large U.S. corporation, the Board of Costco has thirteen directors in 2016, and fourteen directors in 2015. According to 2015 the proxy statement, four board members were inside directors; the other nine were outside directors. In the case of Mr. Sinegal, although he was not a Costco employee in the fiscal year 2015, he was former CEO of Costco until his retirement. He is also a co-founder of the Company. Thus, he is conventionally independent under NYSE standards, but not socially independent. Costco’s Board directors have experiences in the areas of finance, technology, marketing, operations, insurance, law, investments, and telecommunications.
Susan L. Decker, Daniel J. Evans, John W. Stanton, and Maggie A. Wilderotter serve on more than three boards. Among these four busy directors, Susan L. Decker and Maggie A. Wilderotter are female directors. Based on Corporate Governance Guidelines, Costco does not have a policy limiting the number of public corporation boards that a director may sit. However, the Nominating and Governance Committee should consider the busy director problem in the next Annual Meeting.
Comment: Having four busy directors on the Board is too many for the Board to function effectively and focus on important matters.
3. Board Composition
All thirteen Board members are White American born in the U.S. The Company’s Corporate Governance Guidelines do not have a specific stipulation about this. Compared with the average percentage of female directors, which is 18%, the Company’s rate of female directors is 15%. Susan L. Decker and Maggie A. Wilderotter are the only two female directors on Board. The age of directors and executive officers range from 53 to 91. The average age of the Board members is 70, which is older than the average age of the large U.S. corporations.
Comment: The Board has no minorities, and only 2 (15%) out of 14 directors are women. Because Costco operates in many different countries serving various customer groups, a diverse board can help improve performance internationally and domestically.
b. Corporate Governance: Board Committees
1. Audit Committee
Currently, the Audit Committee has 3 members. They are: Mr. Charles T. Munger (chair of the committee), Mr. Daniel J. Evans, and Ms. Susan L. Decker.
2. Compensation Committee
The Compensation Committee has two members. They are Mr. John W. Stanton (chair of the committee) and Mr. Charles T. Munger. The committee has authorized the CEO and Chairman of the Board the rights to grant stock awards to employees.
3. Nominating and Governance Committee
Until January 29, 2016, the Nominating and Governance Committee consisted of 3 members. They were Mr. Jeffrey S. Raikes, Mr. Daniel J. Evans, and Ms. Jill S. Ruckelshaus. After the 2015 annual meeting, the number of members was reduced to 2. The two current members are Mr. Daniel J. Evans and Ms. Maggie Wilderotter.
4. Additional Information
Mr. Benjamin S. Carson, who was the only African-American and served on Costco’s Board for more than 16 years, declared his voluntary resignation in May 2015. Maggie Wilderotter was appointed to replace him in October 2015.
Ms. Jill S. Ruckelshaus was a member of the Compensation and Nominating and Governance Committee until January 29, 2016. However, she was not re-elected as a director. She was replaced by Mr. John W. Stanton as a member of the Compensation Committee and by Ms. Maggie Wilderotter as a member of the Nominating and Governance Committee.
There is a committee overlap. Mr. Munger is the chair of the Audit Committee. He is also a member of the Compensation Committee. This may be because Mr. Munger is a financial expert. His financial expertise helps improve compensation contracting.
c. Corporate Governance: Board Compensation
1. Guideline Requirements
According to the compensation guideline of Costco in the company’s corporate governance guideline, employee directors are not allowed to receive additional compensation for serving as directors. For non-employee directors, they have to own and retain at least 6,000 shares of Company common stock within five years.
2. Actual Earnings
Earnings in 2015
The stock awards amounts were calculated based on the market value of the common stock on the grant date. In 2015, each non-employee director was granted 2,400 restricted stock units. Stock awards compensation accounted for the majority percentage of the total amount received by each non-employee director.
Charles T. Munger and Daniel J. Evans received the highest fees paid in cash. Each of them received $44,000 in 2015. Both Mr. Munger (he is also a member of the compensation committee) and Mr. Evans (he is also a member of the nominating and governance committee) are members of the audit committee. The third member of the audit member, who is Ms. Susan L. Decker, received the second-highest fees paid in cash, which was $41,000. Compared to other directors, Richard M. Libenson received an additional $333,449 due to his engagement as a consultant to Costco.
Comment: The average board compensation of Costco is around $375,400. Costco’s compensation package comprised of heavily of stock. On average, a large company in the S&P 500 pays an annual retainer of $220,000, which 38% is in cash, and 62% is in equity, to a director. The percentage of cash and equity Costco paid to its directors in 2015 was approximately 10% and 90%, respectively.
At the end of 2015, Mr. James Sinegal owned the largest amount of shares among non-employee directors. This is because he is the co-founder of the Company. He used to be CEO of Costco until the end of 2011. He was also President until February 2010. Mr. Munger has the second-largest amount of shares owned (171,777). It is worth noting that he serves in both the Audit Committee and Compensation Committee.
II. Executive Compensation and Incentives
a. Elements of Compensation
The CEO of Costco, Mr. Jelinek, made $6,306,805 as a CEO and President in 2015. It was a 12.2% change from the previous year. Compared to other executives at Costco and the average public executive, Mr. Jelinek’s compensation was much higher. His compensation in 2015 comprised as follow:
- Salary: Mr. Jelinek’s salary was $699,810. It was much higher than the salary paid to other executives at Costco and the average public executive.
- Bonus: Mr. Jelinek’s bonus was $188,800. It was slightly higher than the bonus given to the average public executive and significantly higher than that of other executives at Costco.
- Restricted Stock Awards: Mr. Jelinek was awarded $5,322,962 in restricted stock. It was materially higher than restricted stock awards of other executives at Costco and average public executives.
- Other compensation: Mr. Jelinek was paid $95,233 in other compensation. This was the same as other executives’ at Costco and higher than the average public executive.
Comment: Costco does not require executives to meet the median of its peer group when paying long-term incentives to executives. 87.1% of S&P 500 companies have this requirement.
b. Total Compensation Rewarded
The total stock award value rewarded to Costco’s CEO in 2015 was $5,322,962. The rewarded compensation value was calculated based on the grant-date fair value of performance-based RSUs granted to the CEO during the fiscal year of 2015, 2014, and 2013, which are earned upon achievement of performance requirements and affected by additional time-based vesting.
Comment: There was a decline in the CEO’s equity holdings in 2015. This decline in executive exposure to the Company’s stock may weaken the alignment between the CEO’s interests and those of shareholders. Furthermore, the CEO is allowed to partially or fully accelerate unvested equity awards upon his termination. This gives the CEO realized pay opportunities in the absence of strong performance.
c. Total Compensation Realized
Regarding option awards, the number of shares acquired on vesting to Costco’s CEO in 2015 was $9,243,238 for 84,184 shares acquired on exercise. Because Costco has not awarded stock options since Mr. Jelinek became CEO, option awards that Mr. Jelinek exercised in 2015 probably came from the year 2007 when he was given stock options for serving as divisional COO. In 2007, Mr. Jalinek was given option awards worth $ 866,561 (based on the stock price at that time).
For stock awards, the total amount realized on vesting was $9,570,436. The number of shares acquired on vesting was 73,825. The total market value of shares or units of stock unvested at the end of the fiscal year 2015 was $10,430,333 (based on the closing market price of $139.95 on August 28, 2015). RSUs have vested 20% annually, subject to accelerated vesting depending upon years of service.
d. Performance Metrics
Under Management’s Discussion and Analysis item in its 10-K form for the 2015 fiscal year, Costco stated that the most critical driver of its success is sales growth, specifically warehouse sales growth. The focus of Costco has been mostly on warehouse sales growth. The company treats warehouse sales growth as a substantial component of growth.
Comment: Even though Costco says that sales growth is the most crucial drive of its success, it has not disclosed any specific, quantifiable performance metrics for the CEO. Such disclosure is vital for investors to evaluate the rigor of the Company’s incentive programs.
e. Equity Ownership and Risk
Because Costco’s compensation plan does not give out any stock options, the plan has no convexity. However, restricted stock has been the most significant component of executive compensation. It leads to a large amount of stock held by the CEO and other executives. To a moderate extent, this massive amount of stock has encouraged the CEO to take some risks.
|Costco’s CEO||Industry median|
|Stock Owned (% of Costco)||0.04%||0.12%|
|Total Stock Owned||$14.7 million||$0.02 million|
During 2015, the dominance of Walmart affected almost all of the companies in the retail industry, except for Costco. Its stock price increased by more than 15% and was near its all-time high. This success was in large part due to some risks that the CEO of Costco took. First and foremost, Costco has made a bold decision to adopt Visa and Citi as its credit card providers, replacing American Express. This decision has helped the company attract more members since American Express is not as popular as Visa. Second, Costco has decided to increase its offers in organic products, allowing the company to take more market share from its competitors such as Wal-Mart or Whole Foods. Finally, Costco has made the $55 annual membership fee more valuable by continuing to give its members the best deals for bulk items. As a result, more than 90% of Costco’s members renewed their memberships.
f. Pay Equity, CEO vs. Other Executives
Generally, the ratio of the pay of CEO comparing with other key executives increased during the 2011-2013 period. After 2013, the ratio has been fluctuating modestly. Interestingly, the ratio of compensation of Costco’s chair in 2014 was lower than the average rate, which was 1.75. I included a full table about “Ratio of Pay: CEO Compare with Other Key Executive” in the Excel file.
g. Pay Equity, CEO vs. Average Employee
Costco pays its full-time employees an average of $20.89 per hour. I assume that an average employee works 40 hours per week, making it 2,080 hours per year (52 workweeks). Based on these figures, I calculated that an average employee makes $43,451 per year, not including overtime. In 2015, the CEO of Costco made $6,306,805. The result was that the CEO of Costco was paid 145 times more than the average employee. Compared to other companies’ ratio, which is between 200 times to 500 times, the proportion of Costco was lower.
III. External Auditors
KPMG LLP (KPMG) has served as Costco’s independent auditors since May 13, 2002. According to the 2015 Proxy Statement, upon the recommendation of the Audit Committee, Costco has selected KPMG as the Company’s independent auditors for the fiscal year 2016. KPMG’s major responsibilities are to audit the Company’s annual consolidated financial statements, internal control over financial reporting, and financial statements of certain employee benefit plans, and to review or prepare tax returns. Costco paid $7,135,000 to KPMG as service fees in 2015, and $6,722,000 in 2014. These service fees include audit fees, audit-related fees, tax fees, and all other fees.
Comment: Before KPMG, Arthur Andersen LLP had served as Costco’s external auditors since 1983. However, on May 13, 2002, Costco filed the form 8-K to replace Arthur Andersen LLP with KPMG. I believe the main reason was Arthur Andersen was involved in the Enron scandal, which proved Arthur Andersen did not fulfill its professional responsibilities in financial reporting. Costco made the right decision to improve its auditing quality.
IV. Institutional Shareholders
According to the latest 13F filings, institutional and mutual fund shareholders own 74% of total shares. The percentage of shares held by 5% of owners and all insiders are 1%. The total number of institutional shareholders is 1,299, owning 324,526,465 shares in total. The largest among them are Vanguard Group (28,355,570 shares), Capital World Investors (19,879,084), and State Street Corporation (17,306,135). With respect to mutual fund shareholders, 1,877 mutual funds own a total of 169,704,380 shares. The largest among them are Growth Fund Of America (11,133,183), Vanguard Total Stock Market Index Fund (8,020,055), and Vanguard 500 Index Fund (5,340,398). Finally, 25 insider shareholders own 1,989,622 shares. CEO of Costco is the largest among insider shareholders. He holds a total of 804,419 shares as of December 2015.
Comment: Vanguard Group owned approximately 6.45% of Costco shares as an institutional shareholder at the end of the first quarter of 2016. If Vanguard Group decides to act, it can have a significant impact on Costco’s governance choices.
Appendix A – Corporate Governance Rating in Corporate Governance
I rated Costco’s corporate governance based on the ISS model. My score ranges from 1 to 10, with 1 indicating low governance risk and 10 indicating high governance risk. The rating was given across four pillars: Board Structure, Compensation, Shareholder Rights, and Audit & Risk Oversight. Overall, I gave Costco 3 in Audit; 10 in Board Structure; 8 in Compensation; and 9 in Shareholder Rights.
Board Structure: In my opinion, Costco’s Board exhibits high risks to its shareholders. First of all, Costco’s Board adopted a staggered board with plurality voting. Although this system may be good for anti-takeover purposes, it limits shareholder rights in replacing board members. Second, the tenure of directors is too long. Most of the directors have served on the Board for more than ten years. Some of them have been there since inception. This long-term tenure puts the independence of directors at risk. Third, according to its corporate governance policy, Costco’s Board has four busy directors. One of them sits on five boards. Besides, The Company does not have a policy restricting the number of public corporation boards that a director may sit. Studies have shown that companies with busy directors tend to have worse long-term performance. Fourth, Costco’s Board has only two women and no minorities. The lack of minorities makes Costco’s Board have a higher risk of independence and oversight. Finally, there is a committee overlap on the Board. The chair of the audit committee is also a member of the compensation committee. This can make the Company more susceptible to manipulation. For all of these reasons, I gave Costco’s Board a score of 10, which indicates high risks to investors.
Compensation: In my opinion, the executive compensation system at Costco also exhibits high risk to shareholders. There are several reasons for this. First, there is no disclosure of specific, quantifiable performance metrics for the CEO. Thus, it is unclear whether the CEO has earned his incentives for achieving predetermined performance objectives. Second, there is no requirement for the CEO to perform above the median of the company’s peer group to earn his incentives. 87.1% of companies in the S&P 500 index has this kind of requirement. Furthermore, equity held by the CEO has declined over the last year. This decline in equity holdings may lead to decreases in the alignment between the CEO’s interests and those of shareholders. Last but not least, the CEO can accelerate unvested equity awards upon his termination. The CEO may take advantage of this policy to realize pay opportunities without having to earn them through good performance. For all of these reasons, I gave Costco’s incentive compensation system a score of 8.
Shareholder Rights: Costco’s shareholders do not have many rights in the Company’s corporate governance matters. First, the Company has no antitakeover defenses other than a staggered board. This reduces the premium that shareholders may receive in case of a hostile takeover. Second, Costco’s shareholders have no preemptive rights to purchase additional shares. Thus, shareholders’ ownership may be diluted in the event; there is a seasoned offering. Finally, the shareholders have no right to call a special meeting or take any action in between meetings by written consent. This restriction, along with supermajority voting, severely limits shareholder rights to participate in the Company’s corporate governance matters. As a result, I gave shareholder rights at Costco a score of 9.
Audit Practices: I think Costco has a transparent and robust audit and risk oversight practices. In terms of the external auditor, Costco replaced its long-time audit partner Arthur Andersen LLP right after its involvement in the Enron scandal by KPMG. In addition, Costco has no major audit or accounting controversies over the past few years. For these two reasons, I gave the audit practices at Costco a score of 3, which indicates a low risk to shareholders.
Appendix B – Strategy, Performance Measurement, and Risk Management in Corporate Governance
Costco’s primary strategy is to provide its customers with low priced and nationally branded products. Moreover, Costco imposes a limitation on particular items in each product line to fast-selling models, sizes, and colors. Each Costco warehouse carries an average of around 3,700 active stock-keeping units (SKUs), which is less than its competitors. There are a lot of products that are only available for sale in case, carton, or multiple-pack quantities.
- To give its customer the best value at the best price.
- To become a company that’s on a first-name basis with everyone.
- To treat people right and with respect.
Costco divides its strategy into six different categories: employment objectives, management objectives, business objectives, growth objectives, marketing objectives, and ethics objectives.
Key Performance Indicators
Costco highlights the importance of “member satisfaction” as the company imposes its business strategy. To measure member satisfaction, Costco uses four key performance indicators:
- Sales: fluctuations in same-store sales, website results
- Membership: new members, renewal members, and defections percentages
- Product category results: results in gasoline and groceries
- Profit margin: membership fee (80% of gross profit)
Up to now, Costco has been successful with its business model. The company collected $2.5 billion in membership fees from its members, which accounted for roughly 17% of Costco’s gross profit in 2015. Furthermore, the membership renewal rate was 90% in 2015. These positive results have proved the efficiency and effectiveness of Costco’s business model. However, there are still some risks associated with this business model:
As stated by Costco’s corporate governance policy, the largest problem with Costco’s business model is that the company is becoming too dependent on memberships. The business model will continue to work well if members renew their memberships and continue to shop at Costco. At the moment, the biggest competitor of Costco’s business model is Walmart’s Sam’s Club, which offers similar discounts and other membership benefits. However, Walmart’s Sam’s Club offers different product selections from those at Costco. Costco would face a serious problem if its members changed their preferences and moved to other competitors, such as Walmart’s Sam’s Club. If that happened, Costco would be left with a huge amount of redundant and unwanted goods.
- Omnichannel Experiences
With the fast development of technology, omnichannel is becoming more and more important to companies and customers. Companies can increase revenue by providing their customers with a continuous shopping experience from traditional “street-side” stores to online shopping. On the other hand, customers can take advantage of omnichannel to shop online in the comfort zone of their own house or to compare prices and quality among different vendors. Although Costco generally keeps its prices low, and it is developing its own omnichannel, there is no guarantee that it will successfully integrate the omnichannel strategy into its current business model.
When it comes to buying in large quantities, delivering the products suddenly becomes important. Customers want their goods to be transported home at a low cost or even free of charge. Costco faces some risks in this area as it is not doing a good job compared to other companies. For example, while Costco only offers some online services, Amazon offers free two-day shipping and Prime shipping benefits.
Appendix C – CEO Succession Planning in Corporate Governance
The current CEO of Costco is Mr. Walter Craig Jelinek. He has been the CEO of Costco since January 1, 2012, based on the company’s corporate governance record. Before becoming CEO, he was appointed as president and chief operating officer (COO) in February 2010. The CEO of Costco at that time was Mr. James D. Sinegal. The succession planning at Costco was that the successor to the CEO had to come from within the company. As a result, Costco had appointed Mr. Walter Craig Jelinek as president and COO. Costco also established an Office of the President that included CEO, Chairman, Senior Executive Vice President, and President. The purpose was to make a management transition when the current CEO at that time, Mr. James D. Sinegal, stepped down. As for now, Costco has not been making any proper executive-officer succession planning yet. Mr. Walter Craig Jelinek currently holds both CEO and president positions. There is no COO at the corporate level, only at divisional and regional levels.
Appendix D – CEO Biography
|W. Craig Jelinek Position over Time|
|Executive VP, Divisional COO||2004-2009|
W. Craig Jelinek has been with Costco for over 30 years. He was appointed as CEO at the beginning of 2012, and a director and President since February 2010. From February 2010 to January 2012, Mr. Jelinek served as President and COO. From 2004 to 2009, he was in charge of merchandising. He served in multiple management positions in warehouse operations in the previous 20 years.
Appendix E – Additional Information on Executive Compensation and Incentives in Corporate Governance
1. Compensation Philosophy and Objectives
Costco’s compensation philosophy is to give its executives and employees incentives to make contributions and put efforts into the growth of the company. Costco claims that it has been successfully attracting and retaining quality employees. The company also claims that it has achieved a low turnover in executive, staff, and warehouse management ranks. Moreover, Costco proved its success in its compensation programs by showing 97.3% of advisory shareholders were in favor of the current compensation programs at the 2015 Annual Meeting.
2. Stock Ownership Guidelines
The minimum number of shares an executive must hold is 12,000 shares of common stock.
3. Clawback Policies
If financial statements of a given period are restated or adjusted, incentive compensation awarded previously will be reclaimed. If the compensation is not awarded on a formulaic basis, a discretionary basis will apply. Furthermore, remedial or recovery action would be taken if an officer intended to inflate the incentive compensation to that officer.
4. Severance Agreements
According to Costco’s 10-K form, the employment of the company’s employees will not be deemed severance of employment from Costco for purposes of the payment of severance, salary continuation, or other identical benefits. In addition, Costco will be responsible for all liabilities and obligations concerning claims made by its employees in terms of severance pay, salary continuation, and similar responsibilities in connection to the termination.
5. Golden Parachutes
Costco does not have any change-in-control agreements (golden parachutes) with any of its executive officers, director, or employee. In case of a change in control, the Board may accelerate RSU vesting for plans under which RSUs have been granted.
If an executive’s employment is terminated, the executive can only collect the remaining balance of his or her deferred compensation account after the six-month waiting period succeeding the termination of employment.
If the employment of the current CEO of Costco, Mr. Jelinek, is terminated, the CEO will receive an estimated amount of $1.35 million, including a total of cash payment equivalent to one and a half times his yearly salary and target bonus; continued medical coverage of $67,450 under the Company’s medical plans until age 65; and full acceleration of any unvested RSUs.
6. Post-retirement Compensation
Post-retirement compensation of executives is included in perquisites and “other compensation.” Most of the post-retirement compensation is in connection to the 401(k) plan and the deferred compensation plan, which permits the executives to postpone the entire salary and bonus. The deferral period is at least five years and the matching credit vests over five years. If an executive has reached a sum of age and years of service of 65, the vesting period is shortened to 1 year. Bank of America prime rate will be used as an interest rate for the deferred amounts. Based on its corporate governance guideline, Costco does not maintain a pension plan or post-retirement medical plan for any of its executives.
7. Pledging and Hedging
Costco’s corporate governance guidelines forbid directors and executive officers from hedging and pledging of Costco shares without the approval of the Board and designated Trading Compliance Committee.
8. Discretionary Component of Compensation Plan
Costco’s employees are offered a discretionary 401(k) plan contribution, which allows pre-tax deferral, for which Costco matches 50% of the first $1,000 of employee contributions. Furthermore, Costco gives each eligible employee an annual discretionary contribution established on salary and number of years of service.
9. Criteria for Awarding Variable Pay
There is two criteria for the fiscal year of 2015 performance-based RSU grants (measures based on local currencies):
- 5% increase in total sales compared to 2014
- 3% increase in pre-tax income compared to 2014
After the end of 2015, both goals were exceeded, and NEOs earned their RSUs granted.
10. Compensation Consultants
Although Costco’s charter allows the Compensation Committee to engage compensation consultants, the Committee has not used any since 2006. Compensation Committee has used a peer group to design Costco’s compensation packages.
11. Peer Group, Compensation Design
The peer group of Costco consists of five companies: Walmart, The Home Depot, Target, The Kroger, and Lowe’s. Among these companies, Walmart also has the same membership warehouse model, which is Walmart’s Sam’s Club. Compared to the gross profits of all five companies in 2015 in the peer group, Costco’s gross profit was the lowest, especially lower than Walmart. We think the reason why Costco included Walmart into its peer group even though Walmart is substantially larger is that Walmart has the same membership warehouse business model as Costco’s. Because all the companies in the peer group are larger than Costco, Costco does not use data from these companies to set mid-points or other specific quantitative comparisons, but only for general reference.
12. Peer Group, Performance
|Company||Gross Profit in 2015||CEO’s compensation in 2015||Compensation to Gross Profit ratio||Dual role|
|Costco Wholesale Corporation||$15,134,000,000||$6,306,805||0.04%||CEO is not Chair|
|Wal-Mart Stores Inc.||$120,565,000,000||$19,070,249||0.016%||CEO is not Chair|
|Target Corp.||$21,340,000,000||$28,164,024||0.13%||CEO is also Chair|
|The Home Depot||$28,954,000,000||$10,171,865||0.035%||CEO is also Chair|
|The Kroger Co.||$22,953,000,000||$9,489,186||0.04%||CEO is also Chair|
|Lowe’s Companies, Inc.||$19,558,000,000||$11,625,582||0.06%||CEO is also Chair|
One interesting point I noticed is that the compensation of Brian C. Cornell, who is the current Chairman and CEO of Target. Although the gross profit of Target in 2015 was much lower than that of Walmart, the compensation of Mr. Cornell was higher than that of Walmart’s CEO.
Appendix F – Accounting Quality and Transparency
Costco focuses on providing accurate, relevant, and transparent financial reporting to investors. To make the financial statement understandable to the shareholders is the management team’s primary duty. The role of Costco’s auditors is to assess and express an opinion on whether the company’s financial statement adequately comply with regulatory accounting standards. Accompanied by the support of the Audit Committee, the management team, and the auditors, Costco insists on ensuring that the investors have the proper insight into the business, the key metrics that represent the health of the operations, and the information necessary to make investing decisions.
Appendix G – Financial Restatements (Form 8-K) in Corporate Governance
Since the beginning of 2016, Costco has filed the Form 8-K four times. The first statement was released on January 29, 2016, and the Form 8-K was submitted on February 01, 2016. Costco announced to declare a quarterly dividend of $0. 40 per share on common stock. On February 04, 2016, Costco filed another Form 8-K regarding the results of the 2016 Annual Meeting of shareholders. On March 03, 2016, Costco filed the Form 8-K to report the second quarter and year-to-date operating results for the fiscal year 2016 and February sales results. The last Form 8-K was filed on April 15, 2016, to declare its quarterly cash dividend on common stock increased from $0.40 per share to $0.45 per share. Since a material error caused none of these four reports in previously published financials, there are no significant fluctuations reflects from the stock price.
Appendix H – SEC Rule 10b5-1
Even though Costco does not disclose to the public that they have entered into SEC Rule 10b5-1, they treat 10b5-1 plan as general references and disclose each trade on Form 4. Costco ensures that all purchases are made from time-to-time, as conditions warrant, in the open market or block purchases, and according to plans under SEC Rule 10b5-1.
Appendix I – Anti-Takeover Provision
Costco does not have any anti-takeover measures (poison pill provisions, golden parachute contracts for executives) in place, apart from the staggered board, which ensures that hostile acquirers must win at least two elections to gain majority representation.
Appendix J – State of Incorporation
In December 1998, Costco filed the form DEF 14A to SEC to declare the reincorporation from Delaware to Washington had been approved by the Board of Directors. There are two main reasons for the reincorporation: to simplify the business structure and to reduce corporate franchise taxes. In 1998, The Price Company decided to merge with The Costco Wholesale Corporation. Due to this reincorporation, the Company’s corporate franchise taxes in Delaware increased to $150,000. However, the reincorporation from Delaware to Washington helped the Company to reduce the costs to $59.
Appendix K – Activist Investors
In early 2015, two activist shareholders, James McRitchie and Myra Young submitted a shareholder proposal requesting that Costco board adopt a law to limit the tenure of at least two-thirds of the board to less than 15 years. However, the proposal failed by a substantial margin at Costco’s 2015 Annual Meeting.
Appendix L – ISS Rating
According to Institutional Shareholder Services (ISS), Costco’s governance quick score as of May 7, 2016, is 10, which means that Costco’s governance exhibits high risk (1 indicates lower governance risk, while a 10 indicates higher governance risk). The table below shows the main components of Costco’s score.
|ISS Governance QuickScore Pillars|
|Board Structure: 10||Compensation: 9|
|Shareholder Rights: 10||Audit & Risk Oversight: 2|
In publicly-traded companies, there is a separation between the ownership and their management. Executives may take actions that benefit them, with shareholders bearing the cost of their behaviors. These costs are generally known as agency costs. To prevent executives from making decisions that better themselves at the expense of stakeholders, companies, and boards of directors use performance metrics to evaluate management performance and award compensation.
Performance Metrics Overview
The use of metrics depends on the company’s strategy and operating environment. Certain metrics are broadly used in many companies (such as ROI, EVA, and EBITDA). A limited number of companies use others. For example, sales per square foot are popular among companies in the retail trade sector. This metric allows retail companies to assess the efficiency of a store’s management in creating revenues with the amount of sales space available to them. Real estate is one of the highest costs for retailers. The efficient use of real estate shows that management is getting more profit out of this type of asset.
Performance metrics can be grouped into two categories: financial and non-financial metrics. Financial metrics are usually based on profit (EPS, EBITDA), growth (revenue growth), return on investment (total shareholder return, ROI, EVA), and free cash flow. Non-financial metrics may involve measures such as customer satisfaction, market share, environmental safety, on-time delivery, and R&D productivity.
Research generally supports the notion that companies tend to use a mix of financial and non-financial metrics to measure management performance. Compared to financial metrics, non-financial metrics are more difficult to track with accuracy. According to a study by Deloitte in 2007, 90% of board members claimed that they did not receive any high-quality information related to non-financial metrics. 59% of the respondents also said that the reason for the lack of high-quality information was because the company has undeveloped tools for tracking such metrics.
The Impact of Compensation Mix on the Use of Metrics
Compensation packages are structured to ensure that executive incentives are in line with the company’s objectives. Companies design their compensation packages by using a mix of cash, equity, and other benefits with appropriate performance metrics. As stated by a study conducted by Equilar in 2014, in an average company, CEO’s compensation comprised 29% in annual salary, 20% in bonus, 14% in stock options, 32% in restricted stock, and 6% in pension and benefits. The way a company builds its compensation mix has a significant impact on the company’s use of metrics.
Short-term incentives are often expressed in terms of a target award. Executives will receive an annual cash payment as a percentage of the base salary for achieving the desired objectives. Because these objectives are short-term by nature, the selected performance metrics are usually a combination of accounting measures (such as EVA, EPS growth, and ROA), stock market measures (such as P/E ratio), and non-financial measures (such as R&D productivity, customer satisfaction). According to a study carried out by Equilar in 2013, the most frequently used financial metric among S&P 500 companies was revenue. Revenue constituted 20.2% of all the financial metrics used in annual incentive plans. EPS and operating income were the second and third most frequently used financial metrics, respectively. These metrics give executives an incentive to improve short-term performance by meeting operating targets.
Besides cash incentive plans, companies also use discretionary plans, which do not have rigidly measurable financial targets. At companies with these plans, the compensation committee decides the final executive payout. As indicated by a study by Equilar in 2013, 72% of companies from the S&P 500 had a quantitative incentive plan, which consisted of at least one financial metric. 24% of the company used discretionary plans. Only 4% did not have any annual cash incentive plan.
One problem with short-term incentives is that they may encourage executives to concentrate on short-term accounting results at the cost of long-term value. Thus, these incentives can act as negative performance metrics. For example, a CEO may reduce investments in R&D activities to increase short-term earnings targets, which are tied to his annual bonus. For this reason, long-term incentives are added to the compensation packages to motivate executives to focus on long-term results that benefit shareholders. Long-term incentives are often in the form of stock options, restricted stock units, and performance shares.
Because the purpose of giving long-term incentives to executives is to encourage them to create long-term value, metrics that are linked directly to value creation are usually selected. These metrics include economic profit, growth, and ROIC. For instance, while EPS growth can come from changes in financial structure, which do not create shareholder value, ROIC better reflects how well a company is using its capital to generate returns.
The Use of Metrics in Comparable Companies in the Retail Trade Sector
The five companies that I chose to include in this post to illustrate my points are in the retail trade sector. Those five companies are Wal-Mart Stores Inc., Target Corp, Dollar General Corp, Sears Holdings Corp, and Family Dollar Stores.
Walmart Stores, Inc.
Most of Walmart’s target direct compensation (TDC) of Named Executive Officers (NEO) depends on how NEOs achieved specified performance targets related to key metrics. Those metrics are operating income, sales, and ROI. All of the metrics that Walmart uses are accounting-based.
First of all, by combining operating income, sales, and ROI, Walmart can reduce the risk that their executives only want to pursue results of one metric to maximize the payouts they receive. For example, if executives make a plan to increase sales but negatively impact operating income or ROI, their incentive pay that is built on sales may grow, but it will be offset by decreases in incentive pay based on operating income and ROI. Second, sales and operating profit are short-term incentives, while ROI is a long-term incentive. This combination of short and long-term metrics helps Walmart reduce the risk that executives may take excessive risk in the short-term to improve performance but may cause damages to the company in the long term.
Target focuses more on long-term incentive (LTI) program rather than a short-term incentive plan (STIP). As a result, the company’s executives have not earned any financial payouts under STIP over the past two years. The metrics that Target uses to evaluate its executives’ performance and contributions are total sales growth, digital channel sales growth, EBIT growth, and return on the invested capital modifier. All of the metrics that Target implements are accounting-based.
First of all, total sales growth is chosen because Target wants to increase localization and personalization. For the second metric, currently, Target is developing a multichannel strategy that enables its customers to engage with the company anywhere, anytime. This is the reason why Target chooses digital channel sales growth as its second metric. Besides, EBIT growth is determined because Target wants its profit to grow sustainably, and this growth is fueled by optimizing expenses. Finally, return on invested capital modifier is chosen because, as said earlier, Target concentrates on its long-term incentive program rather than its short-term plan. To sum up, the metrics that Target uses are chosen because of the company’s strategies of growing and its emphasis on a long-term incentive plan.
Dollar General Corp
Incentive compensations at Dollar General are performance-based. NEOs are also exposed to the fluctuations in the price of common stock. The metrics that Dollar General uses are adjusted EBITDA/ROIC, adjusted EBIT, and adjusted EPS. All of the metrics are accounting-based.
NEOs are given performance share units if they meet the EBITDA/ROIC goals. EBITDA is chosen as it is used to evaluate the company’s profitability in stock analysis. It is one of the most widely-used performance metrics. Dollar General wants to ensure that its NEOs are trying their best to make a profit at a stable stock price. However, since EBITDA does not include tax or capital expenditure, such as depreciation and amortization cost, it is not effective when it comes to evaluating NEOs’ performance in the long run. As a result, Dollar Tree puts 50% weight in ROIC (EBITDA weighted 50%). By using ROIC, Dollar General can see whether the projects that it has invested in bring value to shareholders.
EBITDA and ROIC are used together to make sure that invested capital is providing an appropriate return over time, and the interests of NEOs align with shareholders’ interests. The second metric is adjusted EBIT. Because adjusted EBIT provides measures of performance in the short term, it is used for the sole purpose of rewarding eligible employees of cash bonuses in the 2014 Team Share Incentive Program. Lastly, adjusted EPS is used to evaluate the company’s performance from the perspective of investors. The ultimate goal of Dollar General’s executive compensation program is to serve the long-term interests of its shareholders.
Sear Holdings Corp
Incentive compensations at Sears Holding are performance-based as well as long-term-time-based. The metrics which are used are EBITDA or a combination of EBITDA and business unit operating profit (BOP). The compensation awards to NEOs only become payable following a three-year performance cycle. All of the metrics are accounting-based.
Because EBITDA is a good metric to evaluate profitability in the short term, Sears Holding only offers awards based on three-year performance periods. By doing this way, the company can motivate its executives to focus on long-term performance. BOP is used in combination with EBITDA because Sears Holding wants to assess the performance of not only the whole company but also business units in a given performance period.
Family Dollar Stores
Family Dollar’s compensation programs are designed to balance long-term performance with shorter-term performance. The programs are also made to reduce any risk that a NEO would be motivated to go after results only in regard to a single performance metric or performance period. The metrics that Family Dollar uses are earnings per diluted share, sales per square foot, and return on stockholders’ equity. Out of three metrics that Family Dollar uses, only sales per square foot is neither return-based nor accounting-based. The other two are accounting-based.
The first metric is diluted EPS. It is chosen because the company wants to make certain that compensation is proportional to the return on investment earned by shareholders, and NEOs will try their best to increase diluted EPS. Likewise, sales per square foot and ROE are used because they enable Family Dollar to measure the efficiency of its NEOs in generating profit out of the money invested by investors, thus bringing good returns for them.
Comparison of Metrics Usage across Companies
The most important similarity between all five companies is that all associates and executive officers are prevented from hedging or short-selling company stock. They are also subject to significant restrictions on pledging company stock or anything that can eliminate or limit the risks and rewards of the company’s compensation programs. All companies issued stock ownership guidelines applicable to their NEOs. Another similarity is that all five companies chose metrics that enabled them to measure performance related to sales and profitability. These performance metrics are significant indicators for judging retail performance. Moreover, sales and profitability metrics help companies design competitive compensation programs because they can compare their programs to the programs at other companies.
Walmart: Walmart uses sales, operating income, and ROI metrics to evaluate the company’s performance both in the short-term and long-term. Because good performance with respect to these metrics will transfer into shareholder value over the long term, the company does not use EPS or stock prices as a measure to keep its executives’ interests align with those of stockholders. Another reason why Walmart does not use EPS or stock prices is that the price of Walmart’s common stock has historically been substantially less volatile than the common stock of most of the other retail companies. Therefore, choosing metrics based on stock prices is unnecessary and inefficient for Walmart.
Target: Target wants to make sure that its executives are following transformational plans set by the Board during the important time in Target’s transformation. As a result, it focuses more on the growth aspect of sales figures. The other four companies use sales and profitability metrics to measure their executives’ performance in the short-term.
Dollar General: Dollar General applies pay-for-performance philosophy in its compensation programs. In a way, this is similar to Walmart, as both companies use metrics related to financial performance to determine NEOs’ compensation. However, while Walmart does not use EPS as a performance measure from the investors’ perspective, Dollar General uses adjusted EPS to evaluate its NEOs. A possible reason for this is because Dollar General’s stock prices fluctuate more than the stock prices of Walmart or Target.
Sears Holdings: Similar to Walmart, Sears Holdings uses sales and profitability metrics (EBITDA and BOP) to measure business performance. This is because the company’s compensation philosophy is to encourage growth and create increased stockholder value through the efficient use of corporate assets.
Family Dollar: Unlike the other four companies, the metrics that Dollar Store uses are more direct to shareholders (earnings per diluted share, sales per square foot, and return on stockholders’ equity). The company emphasizes on enhancing stockholder value. It is also the only company to use sales per square foot, which is unique to the retail industry, as a metric. The reason for this is because compared to other companies, the financial results of Family Dollar were not good in recent years. Consequently, the company developed plans to improve sales growth by increasing the number of stores and building customer loyalty. That’s why the company uses sales per square foot metric to measure its progress. In addition, Family Dollar wants to keep track of its investors’ return by using earnings per diluted share and return on stockholders’ equity. The company’s stock price has been volatile because of its negative financial results.
The use of metrics to align executive incentives with company performance targets is one of the most critical factors of short-term and long-term organizational success. Different companies use different combinations of metrics to evaluate their executives’ performance. There are many reasons for the variation in the use of metrics among companies, including, but not limited to, the company’s strategies, plans, past performance, and corporate structures. Regardless of the combined metrics that a company uses, those metrics must reflect the true state of the company’s health and help the board of directors and management navigate the company toward long-term success.
1. German Accounting and Country Demographics
To understand the German accounting system, it is important to get the general ideas about Germany. This country occupies the Western part and the Central part of Europe. Denmark is to the north. Poland and the Czech Republic are to the east. Austria and Switzerland are to the south. France and Luxembourg are to the southwest, and Belgium and the Netherlands are to the northwest. Because of its geographical location, Germany holds a central position in Europe. From Frankfurt, many important European urban and industrial centers can be reached within a distance of approximately 600 miles. Germany’s central position in Europe, along with its communication and transportation infrastructure, makes it the number one logistics market in Europe.
With a population of approximately 81 million, Germany is the largest consumer market in the European Union. In recent years, the German population has increased rapidly due to a significant rise in immigration. For thousands of immigrants from all over the world, especially southern and eastern EU countries, Germany, the largest economy in Europe, is an attractive destination. Consequently, Germany has benefited from the wave of immigrants as it brings a large number of well-qualified and trained people to Germany.
1.3. Number of Accountants and Auditors
According to the Federal Chamber of Accountants, the number of accountants (Wirtschaftspruefer) in Germany was 14,407 (until 1/1/2015). The number of auditors (Buchprüfer) was 3,085 (1/1/2015). Compared to the beginning of 2014, the number of accountants in Germany increased slightly (from 14,390 to 14,407), and the number of auditors decreased slightly (from 3,211 to 3,085).
1.4. Legal System
Germany has a civil law structure established on Roman law, with some references to Germanic law. Because German business law is governed by the principle of freedom of economy, business activities in Germany normally do not need a specific permit or license. In addition, German law often does not distinguish between Germans and foreign nationals concerning investments or the establishment of companies. The legal environment in Germany is stable and transparent. The World Economic Forum ranked Germany as one of the prime countries of 144 competitors in terms of judicial independence.
2. German Accounting and Previous Accounting Standards
2.1. German Accounting History
The origin of German accounting standards starts in the early 1300s. The earliest form of record-keeping originated with Hermann Wittenborg in 1329. Wittenborg’s son Jonathan continued to record-keeping until 1360. The books were merely solo lending and trading transactions that did not incorporate dual accounting entries.
Double-entry bookkeeping started in the early 1500s. Families began trading internationally during the Renaissance. Dual entry accounting originated in commercial parts of Italy sometime earlier. One family, the Fuggers, implemented the system. The family’s chief bookkeeper Matthaus Schwarz wrote bookkeeping instructions titled Threefold Bookkeeping.
German accounting practices originated from code law. The first General German Commercial Code was enacted in 1861 and was based on French codes. The first legal accounting obligation was the French Ordonnance De Commerce of Louis XIV in 1673. The code, known as “Code Savary,” forced journal entries and inventory records of assets, receivables, and debts, which resembles a balance sheet. The law wanted record keeping in case of bankruptcy. If no records were kept, the merchant was said to defraud creditors intentionally. The Code Savary recommended assets and liabilities to be measured at cost or sales value. The Savary influenced the General Law for Prussian states of 1784 and the French Code de Commerce of 1807.
The earliest form of German code law was enacted in 1861. The German Union formed in 1815 after the Congress of Vienna in 1814. The German National Assembly adopted uniform commercial law in 1861 through the “Allgemeines Deutsches Handelsgesetzbuch” or ADGHB, General German Commercial Code. Around 1870, the ADHGB issued regulations matching record-keeping with tax calculations, or “legal book-tax-conformity.” The code required every business to create a balance sheet and inventory records at fiscal year-end. Besides, ADGHB set laws for stock corporations (AG) and limited joint-stock partnerships (KGaA). Asset valuation was based on current values at the balance sheet date. The current value figure aimed to put a ceiling price on asset valuation. However, many German corporations failed in 1870 because companies used current values as the overarching valuation principle, not as a ceiling price.
The Stock Corporation Act was enacted in 1870. This Act, or AktG, required balance sheets and profit and loss statements for stock corporations. AktG eliminated the charter account system. Before its passing, stock companies needed a government charter and were monitored by the government.
The Reich’s Supreme Court later ruled over asset valuation in 1873. The court decided that objectivity was the main principle of asset valuation. As a result, assets had to be valued at their market price at the balance sheet date. This served as the groundwork of German accounting because it ruled that balance sheets exist to determine net assets, which is a company’s ability to meet obligations. Consequently, firms would calculate profit as the difference in net assets. In the 1920s, Eugen Schmalenbach defied the aforementioned accounting theory claiming that financial statements should calculate income to inform investors. German theorists debated the two positions during the 1920s and 1930s.
Germany later reformed asset valuation to historical cost. In 1884, the Stock Corporation Law was amended. The law mandated acquisition costs for assets and depreciation for noncurrent assets. Today, Germany still abides by the historical cost principle. The Stock Corporation Law did not cover limited liability companies. As a result, Germany superseded ADGHB with the German Code of Commercial Law, or HGB, in 1897. The code became effective on January 1, 1900, resulting in the very first GoB or German Generally Accepted Accounting Principles. The GoB set out bookkeeping rules and still exists today.
German accounting regulations changed in the 1900s. In 1931, the great depression led to the emergency decree regarding the stock corporation law, or “Aktienrechtsnotverordnung.” For the first time, German accounting required a true and fair view of financial statements. The law required specific balance sheet and income statement presentations. In response to major accounting fraud, the law required audits for any stock corporation’s annual report. In 1937, Germany amended the law by separating it from HGB through “Aktiengesetz” or AktG, which still exists today. HGB would still be in effect for bookkeeping and financial statements. AktG and the emergency decree were enacted mainly to protected creditors. AktG required fixed assets valuation at amortized cost and current assets at lower of cost or market. Furthermore, AktG forbid capitalizing startup costs and goodwill. These standards clearly encompassed conservative principles to protect creditors.
Germany reformed AktG considerably in 1965. Before this Act, management had the ability to generate hidden reserves. The Fixwertprinzip or fixed value principle forced companies to depreciate assets using a fixed value instead of acquisition and production costs. Companies were using different rates to build up secret reserves. In addition, companies had to prepare group accounts, or consolidation, including domestic subsidiaries. This was important because German consolidation was debated from here on out.
The 1969 Disclosure Act mandated that all legal forms of companies publicly disclose financial statements. Prior to this Act, “Publizitatsgetez,” only stock corporations had to disclose financials. The law originated from the Krupp crisis, a large German steel company that suffered many losses in 1966. Krupp was not incorporated, so it did not have to disclose financial statements. Large non-incorporated companies had to prepare financials, but not publish them. German disclosure was not necessary because accounting served mostly tax purposes. Moreover, German accounting has historically resisted disclosure to avoid revealing competitive advantages. As a result, accounting law spread among commercial and corporate laws.
In 1985, Germany changed the German Code of Commercial law. The European Commission’s (EC) Fourth, Seventh, and Eighth directive were converted into German law as the Bilanzrichtliniengesetz or BiRiLig or Accounting Directives Act. The EC sought to harmonize accounting standards. However, Germany only adopted a handful of about 40 options within the Fourth Directive to maintain German accounting.
The Accounting Directives Act expanded the German Commercial Code. Originally, the Fourth Directive applied to incorporated companies. Later, the Fourth Directive expanded to limited liability companies in Germany. The Third Book of the Commercial Code reorganized other regulations from the Stock Corporation Act, and Limited Liability Companies Act into one. This was known as the HGB. HGB required a management report as well as the main principle of true and fair view accounting metrics. As a result, German group accounting was expanded closer in line with US accounting. German firms had to prepare consolidated financials with “geographically unrestricted consolidation.”
2.2. Reasons behind the German Accounting Principles
Law has historically regulated German accounting standards. Mostly, German accounting standards emerged to fulfill contractual requirements. This section covers the reasons behind contractual accounting standards.
Much of Germany’s economic growth through industrialization was made through bank loans. As a result, Germany is portrayed as a strong debt-based economy. However, Germany did have a strong equity market during the early 1900s. After World War 2, Germany relied more on debt for financing, which stifled capital market growth. Even between the years 1991 and 2010, German corporations raised more money through bank loans over shares. Many small and medium-sized German companies connect with one bank for loans, which is called their “Hausbank.”
The last section noted that AktG and the emergency decree following the great depression enacted conservative income principles. Ultimately, conservatism remained an underlying principle to protect creditors. German accounting standards strive for reliability so that accounting numbers are true and fair for creditor protection. To reach these goals, HGB mandates historical cost and stringent realization principles.
Another reason for contractual based accounting stands is firm size. In 2010, small and medium-sized firms were about 99.3% of all German companies. The European Commission defines small and medium-sized firms as less than 250 employees and 50 million in sales (in Euros). These sized firms are not generally traded publicly. As a result, many German companies do not require value-based financial information due to the lack of investors and the cost of preparing. Because firms are smaller, managers and owners work much closer together. Owners do not require in-depth financial information. Lastly, these sized firms rely heavily on bank loans, as noted above.
German accounting is contractually based due to tax reasons. In 1874, Saxony and Bremen required legal book-tax conformity. Furthermore, Prussia enacted book-tax confirmation in 1891. Thus, accounting information aimed to minimize income taxes. Fewer taxes due align with debt-based economies such as Germany. Accounting information is used to determine taxable income. As a result, companies prefer a conservative profit number. Moreover, debt-based economies such as Germany, require highly reliable accounting information so that tax authorities and companies can easily solve legal issues. As a result, contract or debt-based economies issue accounting standards that produce numbers that most people can agree on so that contracts can be enforced.
3. German Accounting and Current Accounting Standards
3.1. IFRS and German GAAP
Current German accounting standards differ for listed and non-listed companies. In 2005, the European Union (EU) mandated International Financial Reporting Standards (IFRS) for all EU listed companies’ consolidated financial statements. All German publicly traded companies must prepare consolidated financial statements in accordance with IFRS as of 2005. Non-listed German parent companies can either use the German Commercial Code standards (HGB) or IFRS. Single financial statement issuers must use the German Commercial Code (HGB). Germany requires HGB because of the many legal and tax outcomes involved in single financial preparations. Singe issuers can only prepare IFRS statements for disclosure.
German GAAP is based on principles, which come from the bookkeeping principles of the GoB. The GoB is both codified and non-codified. Most of the codified GoB standards and other standards come from the German Commercial Code or HGB. The court’s interpretations of accounting standards make up many of the individual parts of German GAAP because legal requirements do not get into specific subjects like lease accounting. Also, the ASCG technical committees interpret German GAAP. From this origin, it is apparent why German accounting changed so much throughout its history, as noted above. German GAAP adjusted to economic needs. Consequently, German GAAP focuses more on creditor protection due to Germany’s debt-based economy.
German GAAP, or HGB, is used for separate financial statements. These statements are used to determine profit distribution and taxes. Because Germany is debt-based, it was simple to combine tax accounting with financial reporting through HGB. This is known as the conformity principle, which states that companies prepare separate statements for taxes. Companies would prepare one balance sheet for contractual purposes, such as taxes and commercial reasons. Later, more tax laws were adopted in Germany that were separate from HGB. However, some tax specific standards made its way into HGB. For example, HGB allows for additional depreciation figures derived from lower numbers due to accelerated tax depreciation. Besides, options in HGB match tax requirements. German GAAP also has conservative principles different from IFRS, such as lower of cost or market. For example, German GAAP allows for LIFO, FIFO, or weighted average, while IFRS prohibits LIFO. German GAAP differs from IFRS in other ways. German GAAP requires land to be valued at acquisition cost. Fixed assets are valued at acquisition or manufacturing costs. IFRS allows land and fixed assets to be revalued using fair value.
3.2. Brief History of German Internationalization
German company internationalization began in the early 1990s. Daimler Genz was the first German firm to list using American Depositary Receipts on the New York Stock Exchange. At the time, Daimler Benz had to reconcile consolidated net income to US GAAP. Twenty-two German firms listed in the US in 2002, but that number decreased to less than twelve after Sarbanes-Oxley passed.
During the 1990s, a few German firms prepared dual financial statements to attract investors. For example, in 1993, Puma made consolidated accounts in a way that agrees with HGB as well as IAS financial statements. Other companies consolidated to US GAAP, as noted above. German companies needed to produce more than one set of financial statements because German GAAP was not acceptable for equity-based markets. For these reasons, Germany later allowed listed companies operating in different regions to produce financial statements using different standards.
In 1998, Germany codified two important acts in response to the lobbying of German preparers. The Corporate Sector Supervision Act as well as the Transparency Act (KonTraG) required the preparation of cash flow and owner’s equity statements. In addition, the KnoTrag required segment reporting for listed companies. Lastly, KonTrag allowed for a private standard-setting body. KapAEG allowed German public firms to prepare statements under IAS, US-GAAP, or HGB.
3.3. Recent German Accounting
IFRS in Germany is in direct response to an increase in the capital market-based accounting systems. Some argue that the rise in IFRS dominance threatens contractual based accounting systems such as HGB. Countries within the EU may begin to harmonize its standards with IFRS.
Currently, HGB remains for individual account preparation. The internationalization of accounting standards mostly concerns consolidated information. KapAEG and KonTrag kept HGB in place during the 1990s. When the EU mandated IFRS for listed companies, Germany allowed HGB for individual accounts. HGB is vital on a single financial statement level because these statements are the origin of contractual concerns. As a result, German companies can serve contractual requirements with HGB financial statements.
HGB has changed as a result of internationalization. The Accounting Law Modernization Act of 2009 (BilMoG) shifted away from traditional German accounting principles. The Act changed the prohibition of recognizing intangibles during the development stage. Recognizing the development of intangibles follows IAS 38. In addition, the Act allowed for trading securities to be measured at fair value. Historically, HGB would recognize assets at historical cost. Both changes would affect income statements prepared using HGB. These changes had to be banned for tax rules (EStG). As a result, international accounting rules intended for market-based systems changed Germany’s debt orientated Commercial Code. However, a BIlMoG memo stated that HGB statements should be used for profit and tax accounting, and principles should not be affected.
4. German Accounting and Certification
4.1. Name of Certificate
Steuerberater: German Tax Advisor
Wirtschaftspruefer: German Certified Public Accountant
4.2. Requirements for Certification
There is one distinctive state examination that candidates are required to take in order to become a Steuerberater. The exam consists of three written tests and one oral examination. However, not every person is allowed to sit for the Steuerberater exam. Only those who meet at least one of the two below conditions are permitted to sit for the exam:
- Individuals who hold a college degree in business administration, economics, or law, along with practical experience in the field of tax administration with the German state authorities
- Individuals who had ten years of practical experience with a tax-consulting firm (there is an exception with individuals who hold additional degrees such as Steuerfachwirt or Bilanzbuchhalter. The years of experience go down from 10 to 7)
There are different ways to become Wirtschaftspruefer. The most popular approach among German students is to become Steuerberater first and then take several professional qualifying examinations before taking seven written tests. After passing all the exams, candidates are appointed as Wirtschaftspruefer and awarded a certificate issued by the Wirtschaftsprüferkammer (Chamber of Public Accountants – WPK – the private-sector body responsible for the regulation of the audit profession). Before receiving the certificate, candidates must swear the professional oath before the Wirtschaftsprüferkammer.
5. Stock Exchange
5.1. Name of Exchange
There are eight stock exchanges located in different parts of Germany: Frankfurt (largest stock exchange in Germany), Stuttgart (second-largest stock exchange), Munich (no physical presence), Dusseldorf, Hannover (defunct – merged with Hamburg), Hamburg (merged with Hanover), Bremen (defunct – merged with Berlin), Berlin (combined with Bremen).
Please refer to the map below:
Frankfurt Stock Exchange: Located in Frankfurt, the FRA is one of the largest, oldest, and most efficient stock exchanges globally. The FRA posts several indices, such as the DAX, the VDAX and the Eurostoxx 50. The owner of the FRA is Deutsche Borse, which is also the owner of other large German stock exchanges.
Stuttgart Stock Exchange: Being Germany’s second-largest stock exchange after the Frankfurt Stock Exchange, the Stuttgart Stock Exchange deals with approximately 40% of all securities trades in the country. Founded in 1860, the exchange trades in a variety of financial instruments, including equities, bonds, investment funds, and certificates of participation.
Berlin-Bremen Stock Exchange: Established in 1685, the Berlin Stock Exchange was one of the oldest stock exchanges in Germany. The Berlin Stock exchange merged with Bremen Stock Exchange in 2003, under a new name Berlin-Bremen Stock Exchange. After adopting Equiduct Trading, the exchange started to allow more foreign stock trading (with over 6,000 US companies) and to extend its product offerings.
Hamburg Stock Exchange: Established in 1558, the Hamburg Stock Exchange was the oldest in Germany. In 1999, it merged with the Hanover Stock Exchange to create the BOAG Borgen AG. Nonetheless, compared to the Frankfurt Stock Exchange, this new exchange is relatively obsolete.
Munich Stock Exchange: The physical facility of the Munich Stock Exchange was initially situated in Munich. Nowadays, the exchange operates entirely by computer without any physical facility. Users can register and access real-time information online.
Dusseldorf Stock Exchange: Apart from its original functioning as an exchange, Dusseldorf Stock Exchange also offers information and consulting services. The exchange provides the QUOTRIX trading system for securities and GEFOX for closed-end funds.
5.2. Number of Listed Firms
According to the World Federation of Exchanges, until January 2015, the German Stock Exchange (Deutsche Borse AG) has a total of 663 listed companies (587 domestic companies and 76 foreign companies). The number of listed companies in 2015 has reduced by 7.5% compared to 2014 (670 companies – 595 local companies and 75 international companies).
5.3. Exchange Regulations
Individual stock exchanges in Germany are under the supervision of the stock exchange supervisory authorities of the Federal States. These supervisory authorities supervise whether trading on the exchanges is carried out in an acceptable manner in accordance with the Exchange Act (Börsengesetz). The major focus of stock exchange supervision is on the pricing process and on collaboration with the trade surveillance units. In addition, the authorities are in charge of supervising any multilateral trading systems operated by exchanges (off-exchange trading). On the contrary, BaFin is mainly responsible for both solvency supervision and market supervision. Under its solvency supervision (on the providers’ side), banks, financial services institutions, and insurance companies are under the control of BaFin. Under its market supervision (on the investors’ side), BaFin ensures that standards of professional conduct, which preserve investors’ trust in the financial markets, are enforced.
The securities markets in Germany are, among other things, regulated by:
- Stock Exchange Act (Börsengesetz): The Stock Exchange Act is made up of fundamental principles concerning the organization of stock exchanges and other securities markets and the trading and listing of securities. Furthermore, the Stock Exchange Act authorizes the government to enact provisions and regulations in order to protect investors and other related parties and to guarantee the accepted conduct of securities trading.
- Stock Exchange Admission Regulation (Börsenzulassungsverordnung): The Stock Exchange Admission Regulation consists of, among other things, listing requirements, procedures, and disclosure responsibilities.
- Rules of Exchange (Börsenordnung): The Rules of Exchange regulate the internal organization of the respective Stock Exchange, the details of the listing procedure, the proper conduct of trade and price-fixing, and the publication of all information regarding prices and volumes. Moreover, the Rules of Exchange also govern the composition of the management of each Stock Exchange and the appointment of its members.
- Rules for the Regulated Unofficial Market (Freiverkehrsbedingungen): These rules of each Stock Exchange provide for, in particular, the requirements of listing on the Regulated Unofficial Market, e.g., the Open Market or Entry Standard of the FWB.
- Investment Act (Investmentgesetz): The Investment Act was adopted in 2004 and revised by an amendment (Investmentänderungsgesetz) in 2007. Investment funds in Germany work under the provisions of the Investment Act, which regulates, among other things, the activities of domestic fund management companies, the investments eligible for local funds, and the public distribution of units in foreign funds in Germany. The Investment Act was replaced by the Capital Investment Act (Kapitalanlagegesetzbuch — “KAGB”) in 2013 in an attempt to implement the European Alternative Investment Fund Managers (AIFM) Directive into Germany. The rules under the KAGB significantly go beyond the minimum requirements adopted by the AIFMD. It has a much wider reach. It provides exceeding, an integrated codification of the investment law in Germany for open-end funds as well as closed-end funds. Generally, the KAGB provides rules for all types of investment funds and their managers.
- German Banking Act (Kreditwesengesetz): The German Banking Act creates the statutory framework for banking and financial service activities and concentrates on the protection of creditors and bank depositors.
- Securities Trading Act (Wertpapierhandelsgesetz): The Securities Trading Act concentrates on the regulation of trading with securities, financial instruments, futures, derivatives, and similar financial products. Furthermore, it requires the obligation to disclose changes in interests in stock of corporations listed on the Regulated Market as well as other significant information relating to such listed companies (e.g., annual financial accounts, quarterly reports, or invitation and agenda of the annual general meeting). In addition, the Securities Trading Act contains certain specific provisions against insider trading and manipulation of stock exchange quotations and requires certain rules of conduct for financial service institutions providing financial services and ancillary services.
- Securities Prospectus Act (Wertpapierprospektgesetz): The Securities Prospectus Act regulates prospectus requirements for the offering of tradable securities and the exemptions from such requirements. In addition, it requires certain principal rules as to form and compulsory content of a prospectus, prospectus approval by BaFin, and prospectus publication.
- Security Prospectus Regulation (Prospektverordnung (EG) Nr. 809/2004): The Security Prospectus Regulation requires, especially, the details regarding compulsory content, incorporation by reference, and publication of prospectuses.
- Act on the Prospectus for Sale Securities (Wertpapier-Verkaufsprospektgesetz): The Act on the Prospectus for Securities offered for sale applies to offers of securities in companies (e.g., closed funds, trusts) that have not issued tradable securities within the meaning of the Security Prospectus Act.
- German Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz (WpÜG): The German Securities Acquisition and Takeover Act require the form, content, procedural rules, and publication conditions regarding public takeover offers. Besides, the Act requires under which circumstances a compulsory takeover offer must be submitted. Consequently, the German Securities Acquisition and Takeover Act are only relevant with shares in stock corporations listed on the Regulated Market and securities representing such shares (e.g., options, convertibles).
6. Regulatory Body
6.1. Code Law
Historically, German accounting regulations and standards were set by statute law. The Federal Ministry of Justice (FMJ) backed the system. German law has both details and principles. Bookkeeping standards (GoB) must regulate all events for accounting and reporting. The principles of the GoB are codified in the Commercial Code (HGB). Unclear law develops principles for clarity through deductive reasoning. The principle must match the actual law and its intent over accounting. Deductive reasoning leads to judgment over bookkeeping. The Federal Fiscal Court (BFH) hears different sides in principle cases. The court has established bookkeeping principles through its rulings that are backed up by the law. Because German HGB stems from profit and tax accounting, the court’s rulings bind correct bookkeeping when there is no specific rule.
More recently, German law established a private standard-setting board from the KonTraG of 1998. The German Accounting Standards Board (GASB) was formed in 1998. This board was the first shift towards the US private standard-setting. The Accounting Standards Committee of Germany (ASCG) governs the GASB. Before 1998, code law established accounting standards, as noted above. However, GASB has yet to develop any standard-setting expertise. The GASB mainly recommends how to apple GoB, or German GAAP. Also, the GASB advises the FMJ on accounting legal disputes and voices German concerns to international standard bodies. After GASB’s inception, it was tasked with taking IFRS rules and copying them into German Accounting Standards, or GAS. These rules clarified how to perform new preparations set out by KonTraG, such as cash flow statements. GASB also interprets HGB requirements. However, GAS is not mandatory because they focus on group accounts only. Individual accounts are not affected by HGB. As a result, GAS does not change German standards from debt to equity-based.
Once IFRS was adopted in 2005, GASB began interpreting IFRS. Also, GASB communicates German concerns to the IASB. In 2012, the ASCG was no more. Funding went away, and support was nonexistent because the ASCG could not meet the interests of all German firms. However, the ASCG reformed a year later and had two purposes. The new board began to put together expert committees to meet its objectives. The first committee is HGB based. The members are close to the FMJ and offer expertise to the private side of German debt-based accounting. The second committee assists with IFRS rules. The committee communicates with the IASB. The new ASCG does not issue standards like the US system. Both sides seek to please different bases. Some say that this is part of the reason for having national versions of IFRS.
7. Enforcement Body
Germany uses a two-tier enforcement regime; one private and one public. The argumentation behind such a system is that the unlawful practice will be prevented by the existence of the regulatory framework, rather than taking specific actions. The regulatory body will act as a defense against illegal activities. The private entity is FREP. The first tier involves the Financial Reporting Enforcement Panel (the Panel), and the second tier includes the Federal Financial Supervisory Authority (BaFin). The BaFin is responsible for determining whether an error has occurred when the FREP’s opinion differs from that of the company.
7.1. Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)
BaFin (The Federal Financial Supervisory Authority) is a stock exchange regulator and acts as a supervisor of the FREP’s activities. BaFin has the power to re-examine a company’s financial statements at its own discretion. It supervises banks and financial services providers, insurance undertakings, and securities trading. BaFin is an autonomous public-law intuition and is subject to legal and technical oversight of the Federal Ministry of Finance. It receives funding by fees and contributions from institutions under its supervision.
BaFin operates in the public’s interest. Its primary goal is to ensure the integrity of the German financial system. With about 2365 employees working in Bonn and Frankfurt, BaFin supervises 1854 banks, 681 financial services institutions, 592 insurance undertakings, and 30 pension funds as well as 6,069 domestic investment funds and 78 asset management companies. BaFin works to ensure the ability of banks and financial services institutions to meet their payment obligations. Through supervising the market, BaFin also enforces standards of professional conduct. By doing this, BaFin preserves investors’ trust in the financial markets.
7.2. Financial Reporting Enforcement Panel (FREP)
The Financial Reporting Enforcement Panel (FREP) examines financial reporting in Germany since 2005. It is a government-appointed private organization for financial statement oversight.
The FREP has been responsible for supervising annual and consolidated financial statements and the corresponding management reports for all listed companies in Germany. The FREP generally performs its review every four to five years for listed companies, and companies that are not listed are reviewed every 8 to 10 years. If a company is not cooperative while under examination by the FREP, and there is substantial doubt in terms of the quality of the results, the Supervisory Authority (BaFin) comes into play.
Members of this organization are typically professionals who are in either the accounting or financial reporting profession. Companies and audit firms are not allowed membership with the FREP. Within the FREP is a governing board. The governing board consists of 3 to 5 members. The governing board is accountable for setting out the principles for the work of the FREP. Besides, there is a Nomination Committee, which is responsible for electing the members of the Enforcement Panel. The Enforcement Panel is another division of the FREP. There at least five members in this Panel and are required to be accounting professionals. This Panel is responsible for performing audits and reporting the results of their audit.
7.2.1. Examination Process
The Panel will initiate an examination under three general circumstances. One such case is “examination with cause” that occurs when there is concrete evidence of an infringement of financial reporting requirements. The examination may also take place at the request of BaFin when specific indications are present. Lastly, testing can occur without any concrete signs, and the test is simply based on random sampling. According to the FREP’s website, no examination with cause shall be conducted if it is not in the interest of the public. The FREP only examines financial statements if the company is willing to cooperate. If the company s willing to cooperate, the company’s legal representatives are expected to provide accurate and complete information. In the case that the company refuses to work with FREP, the Panel shall notify BaFin, and the investigation is escalated to tier 2.
When starting the examination process, the FREP requests audit reports as well as individual or consolidated financial statements and the related management reports. The FREP also requires a list of unadjusted audit differences. The scope of “examination with cause” is limited to each issue for which evidence of questionable accounting treatment was identified. The FREP is not prevented from expanding the scope of examination if other deviations are found. If the company is unwilling to cooperate, then the investigation is advanced to tier 2 with the BaFin. BaFin can then use its regulatory powers to demand the appropriate documents to audit the company.
At the end of the examination, the responsible FREP members report to the accountable chamber to determine whether the company’s accounting complies with existing standards. If the Panel concludes that the accounting is incorrect, it asks the company whether it concurs with the facts, error, and reasoning. If any failure to conform with accounting standards is identified, the Panel is required to find an answer together with the organization under examination. However, if infringements or violations are discovered to have been done intentionally, the board is to notify the BaFin. The FREP is required to report to BaFin the overall volume and the results of their examinations. Beyond these regular reports, BaFin is also called upon when further actions are necessary. BaFin must take more measures if the Panel finds out violations or if there is non-cooperation.
If the firm does not consent with the error, found the investigation is escalated to tier 2, and the BaFin is now involved, BaFin is informed and orders the publication of error unless the publication process serves no public interest. If the firm does not consent with the error assertion, BaFin will initiate an enforcement examination at the second tier level and publication if needed.
8. Auditing Standards and Procedure
The standardization of accounting provisions there has been a demand for standardized audit requirements. The relevant international organizations in this process are the International Federation of Accountants (IFAC) and the International Auditing and Assurance Board (IAASB). These organizations are responsible for developing the International Standards of Accounting (ISA). The IDW has begun transforming ISA into national auditing standards.
Three organizations are responsible for Auditing in Germany (1) Institut der Wirtschaftsprüfer (2) Wirtschaftsprüferkammer (WPK) (3) Auditor Oversight Commission. Auditor oversight in Germany refers only to compliance with the rights and duties of the statutory auditors. Oversight for accounting matters applies to preparers of financial statements.
8.1. Institut der Wirtschaftsprüfer (IDW)
IDW is a private sector organization in which public auditors and auditing companies are organized voluntarily. The IDW is a privately run organization that was established to serve the goals of its members who make up both individual auditors and German public audit firms. The IDW is an authorizing member of the International Federation of Accountants (IFAC).
The Role of the IDW is to:
- Represent the professional goals of its members at the national and international level
- Undertake technical work related to the areas in which its participants are proactive
- Offer training courses to support trainee auditors and providing professional development
- Encourage members on technical
The IDW Auditing Standards are made up of the German Generally Accepted Standards on Auditing as regulated by the IDW governing the conduct of an audit of financial statements. The IDW also set forth the procedures to be performed. The IDW auditing standards generally conform to the International Standards on Auditing (ISA). Auditors are expected to follow the IDW Auditing Standards as best they can. Any deviations from these standards are to be disclosed in detail in the long-form audit report and mentioned in the auditor’s report.
8.2. Wirtschaftsprüferkammer (WPK)
The Wirtschaftsprüferkammer (WPK) is a corporation under public law, whose members are all auditors, German Auditors, and German Public Audit Firms. The WPK is also known as the Chamber of Public Accountants. The duties of the WPK include the appointment/recognition of new members, quality assurance oversight as well as the staging of countrywide standardized aptitude test. The WPK provides a quality assurance system in order to guarantee that the professional practice by members of the profession is subject to regular, preventive monitoring. The auditing practice German Public Accountants must be monitored by an independent auditor for quality assurance every six years, and to the extent that they audit companies that fall under section 319a commercial code, every three years.
8.3. Auditor Oversight Commission (AOC)
The Auditor Oversight Commission added a new element of public oversight that has been incorporated in auditor oversight in Germany. The AOC has the ultimate responsibility in all areas of supervision as its competences go beyond state supervision. The system of quality assurance by the WPK is subject to the public oversight of the AOC. The system of auditor oversight has to be distinguished from the monitoring in accounting matters. The AOC focuses on compliance with the rights and duties of statutory auditors. Any deviations from the auditor’s responsibilities found by the accounting enforcement bodies are reported to the AOC for further investigations.
9. Accounting Education
9.1. Student Correspondent
To learn more information regarding accounting education in Germany, I interviewed Arne. He is getting his master’s in accounting at FOM University of Applied Sciences for Economics. I asked him questions regarding the profession, the certification process, standards, the appropriate time to use standards, etc.
According to Arne, there are several different types of accountants in Germany, like there is here in the US. Different positions have different requirements. Unfortunately, Arne was not aware of the certification process for all the various positions. Some jobs require a college degree, whereas some positions require only a 3-year vocational training. Also, some professions do not always require official registration. Arne aspires to be a controller. Approximately 100,000 controllers are working in Germany.
Arne was also able to provide some information regarding Germany Statutory auditors. In order to qualify for the German statutory auditor examination, a university graduate requires a minimum of four years of practical experience that is related to accounting after graduating. The student must spend at least two of these four years as an employee of a German statutory auditor, German audit firm, or a cooperative auditing association. Some of the classes required for the auditing position are Auditing, Analysis of Financial statements, General Accounting, Tax Law, Information and computer systems, financial management, and economics.
IFRS has been required since 2005 for those companies that operate or trade internationally. However, Germany lacks advanced educational courses or degrees that are specific to IFRS. Additionally, most schools require courses about IFRS and US GAAP, yet only a few have particular degrees for IFRS or US GAAP. Arne believes that this is an area that could be improved in the accounting education of Germany.
German law regulating the accounting profession does not mention any specific classes students must take for the accounting profession. However, a degree in business administration is a common choice. Similar to the education here, many universities suggest students concentrate in an area related to the Wirtschaftsprüfer profession. Universities strongly recommend students choose courses related to the professional examinations for German Accountants.
A master’s degree related to accounting is beginning to gain popularity in Germany as it may provide for better training than a bachelor’s degree. The primary purpose of most accounting graduate programs is to help students prepare for the certification examination as well as working as professional accountants. After completing the master’s program, students can sit for the professional exam immediately following graduation. In some cases, the course that students took may constitute an equivalent exam. Courses such as commercial law and business administration may be comparable to an exam.
The passage of the Eighth Directive in 1984 sets out international requirements with which education for auditors in Germany must comply to. The minimum standards for the education of persons carrying out statutory audits are as follows: (1) pre-qualification education and training, (2) practical experience, (3) test of professional competence. Educational requirements under the Eighth directive include classes related to audit, financial statement analysis, accounting standards, auditing standards, law, tax law, and other financial economics classes.
|Suggested Accounting Courses|
|Analysis of Financial Statements|
|Consolidated Financial Statements|
|Cost and Management Accounting|
|Information and Computer Systems|
|Business, General and Financial Economics|
|Mathematics and Statistics|
9.3. Challenges for Germany Accounting Education
The internationalization process of accounting and auditing in Germany has made the accounting profession much more complicated as it has here in the US. Beyond a profound knowledge of national rules and practices, auditors are increasingly expected to be familiar with international accounting and auditing standards as well as regulations. These trends represent a substantial challenge for accountancy education as they prepare their future auditors and accountants for such changes.
Researchers claim that the audit scope in Germany is widening due to the changing content and role of financial accounting in Germany. More and more German companies apply IAS or US-GAAP for their consolidated financial statements. Traditionally, Germany accounting has been dominated by characteristics of reliability, objectivity, and prudence. As an attempt to move towards the Anglo-American accounting approach and its implementation, German auditors face the issue of widening their scope in order to comply with different definitions and interpretations of accounting issues. The more German companies that adopt international and US GAAP accounting standards for their annual reports, the more the “Anglo-American” approach will influence accounting education in Germany.
Ethics is a broad term. Different people have different definitions of ethics. Ethics are moral principles that we need to follow so that our actions can benefit society as a whole. Ethical standards vary from country to country, especially in the area of employment. The right way of doing business in one country can be different from the others. Companies in developing countries have different ethical standards from companies in developed countries. This fact can be seen clearly through the example of Vietnam, and the U.S. Vietnam is a developing country. Its economy has been developing rapidly since the country reunited in 1975. Although there are a lot of improvements in ethical standards in employment, many ethical issues still exist and need to be solved by companies in Vietnam. On the other hand, the American economy is the largest in the world. People living in the U.S. come from different backgrounds. It is not surprising that ethical standards in the U.S. will be very different from ethical standards in Vietnam. There are many differences in ethical standards in the area of employment between Vietnam and the U.S. These differences can be narrowed down to three main ones: nepotism, gender discrimination, and child labor. This post helps shed light on each of these three differences in the following paragraphs.
Ethical Standard: Differences in Nepotism
The first main difference in ethical standards in the area of employment between Vietnam and the U.S. is nepotism. Business owners in Vietnam prefer to appoint members of their families to the highest positions rather than outsiders. The reasons why business owners in Vietnam have behaved in this way can be explained by looking back at the way the Vietnam economy developed. The Vietnam securities market officially started to operate in July 2000. Compared to the U.S., which had its first securities market back in 1792, the securities market in Vietnam is still young. Before the Vietnam securities market came to existence, companies in Vietnam were private companies. They belonged to the entire families. There were many cases when the father got old; he gave his company to his children. It continued to be this way for many generations. The problem is when the stock market formed, family companies no longer belong to their own families. Outside investors put their money in these companies. Logically, these outside investors must have some control over the companies in which they have invested. However, business owners do not want this to happen. The thoughts that their companies have to be owned by their families still exist. They tend to avoid hiring new people into managing positions. They try to put their children or their relatives on the board of directors instead. As a result, these companies could not compete with foreign companies.
In the U.S., nepotism is a controversial issue concerning ethical standards. Some people believe nepotism is unethical. After all, a vacant position should be given to a person because he is qualified for the job, not because that person has some kind of connections to the business owners. Other people disagree. They think nepotism is unavoidable and should not be criticized. Either way, American people have a different perspective on nepotism than Vietnamese people. In Vietnam, the majority of the population see nepotism as a regular thing. It would be abnormal to Vietnamese people if nepotism in the area of employment does not exist. As a result, business owners in Vietnam often do not face any public reaction when they hire their family members, even if it is evident that the family members cannot handle the job successfully.
Unlike nepotism in Vietnam, nepotism in the U.S. usually exists in small companies that belong to families. In Vietnam, nepotism can be found in any business, whether they are small companies or big ones. Another difference that can be seen between nepotism in Vietnam and nepotism in the U.S. is the way business owners put their family members in superior positions. In Vietnam, business owners can just give their sons or grandsons high positions. They are not afraid of anything when doing this. Other people, especially employees in these companies, do not dare to say a thing. The employees are worried that they can be fired if they express their concerns. After all, they think that it is not their company and they are there to earn a living. This is why nepotism is one of the reasons that make Vietnam businesses less competitive than other foreign companies. Business owners in the U.S. are more careful when they hire members of their families, especially if the vacant job is advertised publicly. Business owners can be sued for discrimination if the family member is less qualified for the job than another applicant. If that applicant is a female, they can be sued for sexual discrimination.
Nepotism cannot be avoided totally. However, nepotism in the area of employment in Vietnam seems to be more spread out and harder to control than nepotism in the U.S. because of cultural differences and the way the government handles the situation.
Ethical Standard: Differences in Gender Discrimination
The next big difference is gender discrimination. In Vietnamese culture, parents always prefer boys to girls. For Vietnamese people, girls are only good at being a housewife. This is the reason why girls often did not receive any education in the past. Nowadays, the situation has improved. Girls are becoming more educated. As a result, the number of women entering the workforce has increased dramatically. However, gender equality and discrimination in the area of employment are still prevalent.
In Vietnam, gender discrimination tends to happen more in some industries than in others. This trend often leads to poor ethical standards. For example, if a woman wants to find a job to work as an engineer, the chance that she can get the job is lower than a man who is looking for the same position. The stereotype jobs for Vietnamese women are related to housewife’s roles, such as tailors, cooks, kindergarten teachers, etc. Men are linked with the jobs that required intelligence and strength, such as engineers, programmers, architects, etc. Companies in these industries tend to refuse women when they apply for jobs. The problem is the whole society supports this type of discrimination. As discussed above, women cannot work in certain industries due to Vietnam’s history and culture. So if, for example, an architecture firm refuses to hire a female job seeker, everyone accepts it, and they do not want to do anything about it, including the government. This also happens to men. Vietnam’s society often does not accept if men do jobs that are supposed to belong to women. For example, if a man applies for a job as a kindergarten teacher, he is unlikely to get the job. The company will be likely to refuse him, and even if the company approves his application, his family and friends will not accept this fact. He will be seen as a weak man.
Women are also linked to lower-paid jobs, such as workers (especially in garment factories). The fact is that women often earn less than men, even if they work for the same positions. Many people in Vietnam just think that it is natural for a woman to make less than a man. Although Vietnam has laws requiring that women should have the same rights as men in the workplace, no one enforces these laws. Companies still pay women less than men, and most people in Vietnam just accept this fact.
Women in Vietnam also have less chance than men to be appointed to high positions in the company. This is because there are specific characteristics that Vietnamese people believe have to belong to women, such as hard-working, enduring, humble, etc. With these characteristics, women can only handle low positions. Only men can qualify for high places. They possess characteristics that are suitable to be leaders, such as: strong-minded and determined. Businesses in Vietnam are greatly influenced by Vietnamese culture. Companies often give men higher positions, although they are not necessarily better than women.
In America, gender discrimination still exists. Although federal laws have prohibited gender discrimination, even now, it happens consistently. The federal Civil Rights Act of 1964 (Title VII) bans companies from discriminating against applicants and employees based on their gender, race, religion, etc. Another federal law, the Equal Pay Act (EPA), also forbids gender discrimination related to unequal pay for “substantially equal” work. Despite these federal laws, forty-six percent of women think they have faced disadvantages in the workplace because of their gender. Compared to companies in Vietnam, companies in the U.S. also prefer men to women, especially small companies. However, in most cases, gender discriminations in the U.S. are subtle.
The difference in gender discrimination between Vietnam and the U.S. is small. Discrimination is still happening in both countries. That being said, gender discrimination in Vietnam tends to be more conspicuous than gender discrimination in the U.S. It is because the way Vietnamese people think is still in favor of men. The women’s role in Vietnam’s society is believed to be not as important as men’s roles. Companies can choose to hire a male over a female applicant because he is a male, without facing any reaction from the government and society. Women’s jobs are women’s jobs. Men’s roles are men’s jobs. In Vietnamese people’s mind, a man cannot do a woman’s job and vice versa. On the other hand, although gender discrimination still exists in the U.S., women and, in some cases, men are protecting better against it. A person in the U.S. can sue a company if they have enough evidence showing that they have experienced gender discrimination. This person could not do this if he were in Vietnam. For example, in 1971, Martin Marietta Corporation was sued by Ida Phillips, a mother who applied for a job and was rejected. The evidence showed that the company refused to employ female job seekers with preschool-age children but hired male applicants who had preschool-age children. The U.S. Supreme Court held that the company was liable to its female staff members because the federal Civil Rights Act (Title VII) prohibits companies from using different policies for men and women.
It can be seen clearly that gender discrimination in Vietnam is more conspicuous. Generally, companies in Vietnam do not have to be afraid of being liable for their policy, which discriminates against women. It is a whole different story in the U.S. Companies in the U.S. can be responsible for their actions. As a result, U.S. companies are more careful when they want to discriminate against their employees because of the employees’ gender.
Ethical Standard: Differences in Child Labor
The final main difference in ethical standards in the area of employment between Vietnam and the U.S. is child labor. Vietnam is still a developing country. There are many families in Vietnam are living in poverty, especially in the countryside. Not only that, those families usually have a lot of children. It is common for a family to have more than three children. Thus, children born in these families have to work while they are young to support their families. The situation gets worst if the children are from an ethnic minority. Parents often send their kids to nearby factories, notably garment factories, to earn some money. The owners of these factories know that these children are underage, but they still hire them. The most apparent reason is profit. Factory owners have paid these children a lot less than adults. The trouble is nobody cares about this situation. The parents of the children do not care. They are just happy because their kids are making money. The factory owners are also pleased because they can save their money on labor. The government is just so busy with other things that it does not have enough time to pay attention to these little kids.
The situation remains the same in big cities in Vietnam. In urban areas, many companies are hiring children as part of their workforce. These children often come from the countryside. Because wages in big cities are usually higher than in rural areas, low-income families often send their kids to the cities to work, especially female children. In Vietnam, most families still prefer boys over girls. Many Vietnamese people still think that girls do not need to study much. This is why many families in rural areas send their female children to big cities to work. The children working in these factories are being poorly treated. In one factory raided by Blue Dragon Children’s Foundation, an Australian organization that helps children in crisis, about twenty children are staying and working in a small room with the machines. The youngest was eleven, and most of the children were from ethnic minorities. The factory owner only allowed the children to go to the bathroom for eight minutes a day to take a shower, brush their teeth, and go to the toilet.
In America, the main federal law regulating child labor is the Fair Labor Standards Act. For non-agricultural jobs, companies cannot hire children under twelve. Children between twelve and sixteen may only be allowed to work in some situations during limited hours, and children between sixteen and eighteen may be hired in riskless positions for unlimited hours. Industries that employ the most children are the fast-food, retail, garment, and agricultural sectors. These regulations improve ethical standards in the U.S.
Compared to child labor in the U.S., child labor in Vietnam can happen in all industries. The reason is although Vietnam has laws and regulations about child labor, it just does not enforce them enough. Children in Vietnam are not being protected as much as they are in the U.S. In America, companies are more careful when they use child labor, even if using child labor does not take place in the U.S. In 2012, The Louisiana Municipal Police Employees’ Retirement System sued Hersey, the largest chocolatier in North America, to a Delaware court, claiming that Hersey knew about the company’s suppliers illegally hired child labor in West Africa to pick and gather cocoa beans. The court finally dismissed the case, stating that the plaintiff did not have enough evidence to prove that Hersey had used child labor to harvest cocoa beans.
The industries in the U.S. that hire most children are the ones that do not receive much attention from law enforcement. One report showed that inspectors take very little time (around five percent of their time) to examine child labor issues. Once a regular company is inspected, it would be approximately fifty years for that company to be investigated again.
Another difference in child labor between Vietnam and the U.S. is where the children come from. In Vietnam, child labor often happens among children from ethnic minorities or the countryside. Factories built in the countryside often hire these children to work without any problems. These children can also be sent to big cities by their families to work for small-size companies in the hope of a higher salary. While in the U.S., companies often hire children of immigrant families. Although the origins of the children in the U.S. and Vietnam are different, they all share a common thing, that is, their families are living in poverty, and they have to work hard to support their families. Business owners are taking advantage of them, and they only want to exploit these poor children as much as possible.
It can easily be seen that child labor is still happening both in Vietnam and the U.S. However, the situation is much worse in Vietnam due to the lack of laws and regulations. Business owners are only thinking about profits. They do not pay much attention to ethical issues until the government tells them to do so.
The three main differences in ethical standards in the area of employment between Vietnam and the U.S. are nepotism, gender discrimination, and child labor. The ethical standards of employment in Vietnam mainly derive from its culture. Vietnamese people think that money and property of parents should be left to their children when the parents get old (nepotism). They also believe that Vietnam’s society appreciates men more than women in many fields (gender discrimination), or families in Vietnam tend to have many kids even though they are living in poverty. They prefer boys to girls (child labor). Consequently, businesses in Vietnam act accordingly to the way Vietnamese people think when they hire new employees or discharge their current ones. The three main problems discussed in this essay exist both in Vietnam and the U.S. However, these three ethical problems are more rampant in Vietnam because Vietnam society is taking the company’s sides. Hopefully, Vietnam’s community will change accordingly with its economy, and these ethical issues will be put under control by the government in a better way.
As you can see, my website is for personal use and it has an org domain. Initially, the purpose for me to create this website was that I wanted to have an online place to display my resume, skills, education, and career information for my job hunts. I put the address of my site on the hard copies of my resume when applying for jobs. Since not all job applicants have a resume website, I thought mine would give me an advantage. I did not want to choose .org as the generic top-level domain (gTLD) for my site at first. As with everybody else, my first option was .com. However, as I was not satisfied with all the .com domains I could find, I started to look into other extensions, such as .net or .org.
My goal was to find a name that is easy to say, easy to spell, easy to remember, and not to exceed two words and ten characters. I finally found happytime.org. It meets all my criteria for a name, except for the fact that it ends in .org. I hesitated for several minutes, and then I decided to go with it. The name “happy time” has more profound meanings to it. I want the times that I spend on building my website to be my happy times. I also wish that other people would feel happy when browsing my site. Lastly, I will post any of my happy pictures and share any of my happy moments on this site. Therefore, it is perfectly rational for me to name my online home “happy time.”
While doing some Google searches on the differences between .com and .org gTLDs, I found out that people generally assume that .com domains are for for-profit websites, and .org extensions are for non-profit ones, even though everyone can register for a .org or .com domain without any restriction. With this kind of stereotype, it seems like a bad idea to choose a .org extension for a personal blog. Nonetheless, as I think about it more, the concept of using .org for private purposes becomes more sensible to me. I came up with six reasons for my belief.
.com is not as popular as people think.
It is undeniable that .com is the most common domain extensions on the internet. A few reliable sources on the web claimed that the percentage of .com websites is approximately 50%. However, is it true that .com domains are that much popular? Is it true that roughly half of the internet websites are using .com? As you may know, there is a thing called domain name speculation. Countless companies and individuals have spent their money buying innumerable domains and hold on to them. Those entities do not use the names they acquired. They just let their inventories sit there unused and will sell them later if they receive good offers. As can be seen, the number of used .com domains is more than likely inflated. No one knows how many .com domain names out there are registered by cybersquatters. Of course, other extensions also suffer from cybersquatting, but .com is affected the most due to its popularity. Furthermore, may websites whose main web address is in a different extension buy .com domains to protect their brand. The .com domains are used to redirect those sites’ visitors to their primary address. For instance, when you type in Wikipedia.com, you will be taken to Wikipedia.org.
Org domain is for noncommercial websites, which include personal sites and blogs
Second, as stated by countless sites on the internet, .org should be used by non-profit organizations only. Even though I am not an organization, I do not plan to sell anything on my site. It is the place for me to share what I want to share with the world. The only money-related thought I have is to place some advertisements and write a few affiliate marketing posts to earn some income to pay for the costs of maintaining the website like hosting fees and domain renewal fees. Technically speaking, my site is not for profit by any means. Going back in time to when .com and .org were first introduced in 1985, .com was intended for commercial uses, and .org was for everything else that could not fit in with other gTLDs. Based on this historical rule, .org seems like an excellent choice for personal websites and blogs.
Domain extensions are becoming irrelevant
Third, as there will be more and more people like me who use .org domains for different purposes, the original intention for .org will keep fading off over time. Maybe ten years from now, the general public will no longer see websites with .org extensions as something exclusive for noncommercial uses. This is similar to what .net sites have been going through. The .net was meant for networking companies from day one. However, as time went by, people used .net extensions for all kinds of causes. The idea of the dot net for networking technology entities disappeared.
In addition, nowadays, an average internet user does not type in the full URL of the webpage that he or she wants to visit. Alternatively, that person will just simply enters the name of the page into the address bar and click on the very first link in the search result. Thus, domain name extensions are becoming less relevant and less important. Besides, Google stated that domain extensions are not a factor in its SEO algorithm.
More org domain available than .com
Fourth, since fewer people use .org domains, there are more beautiful names available. If one insists on using a .com, he or she has to either pay a lot of money to acquire their desired names or come up with longer and less memorable versions of the names. Whether a long ugly misspelled .com name is better than a short generic .org name is up to each individual to decide. Still, it is easier for visitors to remember a nice .org name than an unattractive .com one. Some would argue that people will assume any website’s address ends with a .com. I disagree with this view. If people want to remember a web address, they will remember everything about the address, including the domain extensions. If they are unsure, they will use search engines.
Many popular big international websites use org domain
Fifth, while I can go with .net, .info, or whatever, I think .org is the second-best option after .com for website owners in terms of long-term values and reliability. One of the reasons why .com is so popular is that nearly all biggest websites use .com extensions. From Amazon to YouTube, it has always been .com. These biggest sites have millions of daily users worldwide. Nevertheless, some of the biggest sites use .org. Wikipedia is one of them, among many others, such as Mozilla, International Monetary Fund, Red Cross, WordPress, Craigslist, etc. These big names have global influences, and they are what bring values to .org domains. For .net, the only big names that I can think of are SlideShare and PHP. For other extensions, I cannot figure out any entities associated with them. If gTLDs were ranked based on this standard, dot com was number one, followed by dot org. The dot net would be in third place.
.org is under close watch
Finally, .com, .org and .net consistently receive everyone’s attention. If something happens to any of them, people will talk about it as well as take action. For example, when Ethos Capital wanted to buy the dot org for one billion dollars in 2012, many stakeholders, including the Attorney General of California, raised their concerns and objections. The reaction from these parties helped stop the sale. What if Ethos Capital had wanted to buy the .info or the .biz, instead of the .org? I imagine no one would have cared, and the sale would have been able to go through. What I learned from this incident is that it is safer to invest money in buying .com and .org domains. There are fewer chances of something bad (e.g., unreasonable price increases) happening to them because the public keeps a close watch on them. After all, they are online homes to nearly every powerful corporation and organization around the world.
To conclude, I agree that .com is still the best. However, it is not a big deal if a .com name you want is not available. It is not a bad choice to go with either a .org or a .net. There are logical reasons for using .org domains instead of .com names. If you are reading this and considering .org for your future website or blog, go ahead and take it. I hope you have a happy time reading this post.
Globalization cannot be progressing without cross-border capital flows. These capital flows can exist in the form of foreign direct investment, stock and bond purchases, and lending. Although there are many benefits that cross-border capital flows bring to globalization, there are still disadvantages. One of the most outstanding disadvantages is that during the time of a global financial crisis, capital flows can spread the crisis from one country to another. This post aims at clarifying the risks of the occurrence of global financial crises as well as how multinational corporations can limit those risks when raising funds to meet their short-term financial obligations and long-term investment needs.
Reasons for 2007-2008 Financial Crisis to Occur Again
There are three main reasons why the 2007-2008 crisis can occur again. First, big banks are getting even bigger nowadays. Ten biggest banks in the U.S. possess more than half of the assets of the top one hundred banks. Among the ten biggest banks, JPMorgan Chase has increased its total asset more than 100 percent over the past decade. The problem with giant banks is that if they failed, the whole financial system would collapse. In 2008, the growth of a variety of financial instruments, such as credit default swaps, removed the blockade between investment and commercial banks. This removal gave banks an incentive to take excessive risks when lending money. Those extreme risk-takers ultimately caused a global financial crisis. If the biggest banks were to retake unreasonable risks in the future, the chances that they would fail and drag the whole economy with them were notable.
The second reason that may cause financial crises to happen again is the devaluation of the dollar (and other stable currencies). The U.S. economy was in recession at the beginning of 2001. To combat the recession, the Federal Reserve started to devaluate the dollar to help exports and stimulate the economy. However, by weakening the dollar, the Federal Reserve accidentally discouraged people from keeping money. Instead, they turned to hard assets, such as the housing market, as a safer channel. Besides, a weaker dollar made everything more expensive and higher inflation. Combining these two factors, devaluating the dollar led to the housing market bubble, which then caused a financial crisis. If the U.S. government decides to devalue the dollar again to fight against recession in the future, the chance that it may cause another crisis is highly possible.
The third possible cause of the next financial crisis is the U.S. budget deficit and national debt. The budget deficit is projected to reach approximately 900 billion dollars at the end of 2019 and more than 1 trillion dollars in 2021. The national debt has reached around 80% of GDP in 2018 and will be increasing to 100 percent in 2017. When American and foreign creditors are aware of the government debt and deficit situations in the U.S., they are more likely to increase their interest rates on U.S. debt. Every time the creditors increase the interest rate by 1 percent, the U.S. deficit will increase by more than 1 percent. It can lead to a slower economic growth rate and eventually create a recession and financial crisis.
Minimizing the Risks of Occurrence of Global Financial Crises
With the reasons mentioned above, there are several ways to mitigate the risks of a global financial crisis happening again at some points in the future. The first way to reduce such risks is to tighten the regulations on mortgage brokers who made terrible loans without worrying about the creditworthiness of borrowers. In the 2007-2008 global financial crisis, banks did not care about the credits of the borrowers. They simply resold those loans on the secondary mortgage market. In addition, a large number of homeowners took out loans with high-interest rates. When the housing market burst and the housing prices fell sharply, homeowners could not sell their houses for a profit to repay their debt. Consequently, they defaulted. The government had only one choice to buy bad loans to rescue the market. Therefore, to reduce the risks of a future financial crisis, regulations should be tightened to force commercial banks to focus on borrowers’ creditworthiness and only lend money to those with strong credit scores. These strict regulations can help reduce bad loans and, thus, mitigate the risk of a crisis.
The second way to reduce the risks of another financial crisis is to require banks to increase their equity capital. At the time of the 2008 crisis, banks relied heavily on debt to finance their operations. At the moment, when the economy is relatively stable, banks should be required to raise their equity so that when the economy is in recession, the risk of a financial crisis is mitigated. The third way to reduce the risks is to ensure that financial institutions are not too big. If one troubled bank is too big and deeply interconnected with other banks, when that bank fails, it will drag the whole financial system down with it. This risk would be significantly reduced if the troubled bank is not so influential on the entire system.
Ways That Multinational Firms Can Limit the Impact of Future Global Financial Crises
One of the popular ways that multinational companies to meet their short-term debts is issuing commercial papers. International firms always look for buyers who want to buy mortgages. Those buyers do not wish to purchase obligations from banks or the government because of low-interest rates. Instead, they are willing to buy debts from big multinational companies due to higher rates of return. Typically, commercial papers are considered a safe investment channel for investors because they have short maturities, and companies who issue the papers have good credit ratings. Multinational companies mainly issue commercial papers to meet their short-term debts, such as payroll obligations or paying vendors. During the 2008 crisis, the commercial paper market nearly collapsed. As a result, Federal Reserve had to intervene by directly buying as many commercial papers as it could support both investors and the corporations that issued the papers.
As can be seen, investors are less willing to buy commercial papers in the course of a financial crisis because the risks are higher. To limit the impact of future global financial crises on their ability to raise capital to meet short-term obligations, multinational firms can issue asset-backed commercial papers instead of regular commercial papers. Asset-backed commercial papers are safer because those papers are backed by real assets in case firms fail to pay. Because demand for commercial papers decreases during financial crises, it is harder for multinational firms to raise capital. By issuing asset-backed commercial papers, firms can guarantee investors of their ability to pay back their debt and, hence, can raise money more efficiently.
To fund their long-term investments, multinational corporations can issue either stocks or bonds. During economic booming, when investor’s confidence is high, it is easy for big corporations to raise funds through stocks. They can sell their shares at a high price. However, trading stocks is not a good option. During the 2007-2008 global financial crisis, the cross-border stock market crashed due to the panic of the investors. They aggressively sold their stocks, resulting in dramatic price drops. Therefore, companies could not rely on selling shares to raise capital funds throughout a financial crisis. When stock market crashes, issuing bonds is a better option for multinational firms. Generally, bonds are a safer investing channel than stocks, especially in the time of economic crises and downturns. Compared to stocks, bonds have a fixed interest rate. Investors know the interest rates before they invest. Through financial crises, while the rate of return from stocks significantly decreased, the profit from bonds stayed the same (if investors bought the bonds before the crisis).
Moreover, bondholders are promised to be paid back while stockholders may get nothing in return. Because businesses did not do well in financial crises, they paid fewer dividends if at all to stockholders. Bondholders, on the other hand, were still got paid regardless of the business situations. For these reasons, multinational firms should raise their long-term capital funds through bonds to limit the impact of a future financial crisis.
Summary and Conclusions
To mitigate the risks of occurrence of a future global financial crisis, governments should pass more laws and regulations to put mortgage brokers under control. Mortgage brokers should concentrate more on the creditworthiness of borrowers. Furthermore, banks should be required to hold more equity instead of debts. A low debt-equity ratio will make banks and other financial institutions more stable throughout the time of an economic crisis. With respect to international firms, to limit the impact of financial crises on the ability to raise capital, they should utilize asset-backed commercial papers to meet their short-term obligations and issue bonds to meet their long-term investment needs.
Before creating my website, I did not even know that buying and selling domain names, or even domain name speculation were a thing. There is a big market for it, similar to the housing market. When searching for a nice domain name for my website, I noticed that several short and memorable names were quite expensive. Out of curiosity, I typed those names into the address bar of my browser and went to the actual websites to check them out. To my surprise, those sites contained nothing but some advertisements and a big noticeable phrase, “domain for sale. Make your offer”! I did some research into these abandoned sites. It turns out that those domains are called parked domains, and the sites are just a landing page. They either belong to individuals or domain brokers. These people buy a bunch of functional web addresses and leave them unused until they can find someone to buy the domains at top prices. The domain sellers, often big companies, can be very patient. They are willing to hold on to great URLs for years if they do not receive good offers. They are not creating any value for the internet. They act as a middleman.
I am personally not too fond of this practice of domain name speculation. People who genuinely want to build their websites cannot find domains that match their ideas and intentions. They often end up choosing an uglier version of their desired names or choosing a name that is entirely irrelevant to their website content, while all the great names are still sitting somewhere out there undeveloped. The domain name of this website is a good example. If you look at it, happytime.org, the domain has nothing to do with the web content. Besides, it has the dot org extension, instead of the dot com. The dot org extension is generally associated with non-profit organizations. As you can tell, my website is personal. I choose this name because I could not find any satisfactory alternatives. I am as well obsessed with common names that consist of generic words. I was making an effort to come up with the right name for my website, and this domain was the closest thing I was able to find that was still available. I was thinking of using my name for the web address. Nonetheless, it would be hard for a lot of people to pronounce and memorize it because it is in Vietnamese. What if there are people who want to navigate directly to my site? Ultimately, I want to capture all the type-in traffic by having a catchy domain name.
Unmemorable domains or the mismatch between website content and domain names as a result of domain name speculation can harm website owners concerning search engine optimization (SEO) and website visitors’ trust. It is also more difficult for internet users to revisit the sites that they like. This circumstance has occurred to me multiple times. For instance, there was a website about accounting that I found useful. Sometime later, I needed to learn more about an accounting concept. I wanted to visit that site again, but I did not remember the website domain names because it was just a random name. I tried to search for the website on Google. However, there was no luck. I should have bookmarked the site or something. That is what happens when people rely too much on Google for everything.
Search Engines’ Drawbacks
This paragraph as nothing to do with domain name speculation, but I felt the need to bring this subject up in this post. Regarding problems with search engines, it brings me to the second point that I wanted to make in this post. The websites and information that are ranked high on prominent search engines, such as Google or Bing, are not necessarily the most valuable. The sites that appear on the first pages of search results are mostly due to their excellent SEO work. There were a lot of times that I found low-quality content at the top of Google search results. Some of the standard SEO tactics are: write posts that have more than one thousand words, add internal links that connect various pages on the same site, add keywords, etc.
While Google uses these factors as its main ranking algorithms to my knowledge, I do not think they add much value to the visitors of those websites. Google is doing an excellent job at including relevant content in its search index, but a medium job at showing useful information. Back to my previous example, where I was searching for an accounting site, but I could not find it, all I saw was huge chunks of crappy articles on the first few pages of Google. These posts were long, wordy, and contained repeated ideas. Some of the paragraphs in the posts were completely off-topic. Although I understand that the authors of the posts wanted to make them long and filled them with as many keywords as possible for SEO purposes, their practices destroyed their readers’ experience. Because of these posts, I had to spend more time on my search to find what I was seeking. Generally, I think domain name speculation and SEO are ruining the internet.
The Anticipated Dead of Domain Name Speculation
While I have been upset with this domain market, I do not think it will last long under the current development of the internet and technology. First, big businesses have come up with plenty of new domain extensions, also known as generic top-level domains (gTLDs). These gTLDs can range from something like dot academy to dot zone. I have browsed through the list of latest gTLDs and found some weird ones, such as dot ninja and dot pizza! Who would ever want to use dot ninja extension for their websites? Despite the unpopularity of these new extensions, they can still weaken the demand for dot com, dot org, or dot net to some extent. Thus, domain brokers will have a harder time selling their inventory. The market for domain name speculation will gradually decline. Second, even though search engines are not perfect, and we should not be complexly reliant on them, they are still dominant over direct domain addresses access. This dominance also reduces the needs of popular domain names. Website owners can always do well if their sites’ ranking is high for targeted keywords on Google.
Third, the renewal price of domain names is increasing. ICANN removed the price cap of the dot org extension in 2019. It means that in theory, the registry of dot org, the Internet Society, can increase the price as much as they like. Before the change, they could only increase their rate by ten percent every year. While this is bad news for website owners like me because it increases the maintenance cost that I have to pay yearly, I am glad it is happening. Domain brokers will have to meet any charges incurred to renew the domains on which they have been squatting. An annual increase of a few dollars will not affect me much as I have only one domain. However, for domain businesses who may possess hundreds to thousands of web addresses, their costs will go up sharply. Finally, more and more people use apps on their smartphones to satisfy their needs instead of visiting the actual websites of the app developers. This trend would ultimately lead to the dead of websites. If sites are dying, what chances does the domain market have?
To summarize my long post, the market for buying and selling domains is terrible for website owners and the public in general. In addition, we should not be dependent too much on search engines because they are not perfect. A lot of website owners take advantage of their SEO techniques to promote their sites, but they do not have high-quality content. This is not good for many of us who use Google daily to look for stuff. Lastly, the domain market is dying under the ongoing trend of the internet.
I used to work as an Accounts Payable Specialist for three months. Although it is not a long time, it still gives me an insight into the responsibilities of a typical Accounts Payable (AP) employee and the daily operations of an AP department. I want to share my experience in this post.
At the company that I worked as an AP specialist, there was neither an accounting manager nor an AP manager. My direct supervisor was the accounting director who oversaw both the accounting team and the AP team. There were three employees in the AP team and four accountants. In total, my supervisor managed seven people. For the AP team, we were responsible for processing all vendor invoices, check requests, employee reimbursements, setting up payments, expense accruals, and AP account reconciliations. I can tell you that it was a lot of work for only four people, including my supervisor. She picked up some of the work.
Processing vendor invoices was the most important duty for my colleagues and me every day. Invoices were split among three of us based on the alphabetical order of vendor names. One of my teammates handled invoices that came from vendors whose names starting with letter A to N. I was in charge of vendor names that began with letter M to Z. The other teammate was accountable for utility invoices. The accounting director expected each of her AP employees to process at least two hundred fifty to three hundred invoices per day. She said that she wanted the AP balance to stay at around three to four million at month-ends. It was stressful to meet the weekly targets set by my supervisor. Every Friday morning, she used to hold a meeting between AP staff members to discuss the performance of each member during the week. In those meetings, she also talked about news, what to expect in the following weeks, and asked each of us to share out thoughts and experience. Overall, she was a good manager who was willing to listen and make adjustments.
Vendor invoices could either come in by email or by mail. There was a shared email address set up to receive invoices that came by email. All Accounts Payable Specialists were expected to check the shared email inbox daily. To make everything easy, my supervisor drew up a schedule for going through the shared inbox. I was assigned to monitor the inbox on Mondays, Wednesdays, and Fridays. My job on those days was to save all invoices in the shared folders based on vendor names and answer any vendor questions. For my two colleagues who did not check the shared inbox on those days, their job was to check the mailbox, scan any invoices received, and save the electronic copy of the invoices in the shared folders. On Tuesdays and Thursdays, the assignments were rotated. Checking the shared email inbox was the first thing that I did after I came to work every day. It took me about two hours to complete this task.
After vendor invoices were saved to the shared drives, we sent them to department managers for approval. Accounts Payable Specialists used the HelloSign platform for this task. Basically, I uploaded the invoices of the vendors that were assigned to me to HelloSign’s website. After that, I chose the names of managers who had the authority to approve the invoices. HelloSign would send the invoices to those managers. I would get notifications when the invoices were approved. I then downloaded the signed copy of the invoices and saved them to the shared drives. Approved invoices were kept in different folders from preapproved ones. I spent approximately thirty minutes to an hour doing this task.
Following the approvals of the invoices, I entered them into the accounting system. This was the primary task in the whole process. This task also took the longest time to do. On average, I had to process over fifty invoices per day. A lot of human errors happened here. The most common ones were entering wrong invoice amounts, using inappropriate general ledger (GL) accounts, using incorrect vendor numbers, etc. One mistake that I made several times, especially during the first few days of a new month, was posting invoices to the wrong periods. Because a lot of vendors sent their invoices late, the invoices that I processed in the first few days of a new month belonged to the prior month. Thus, I needed to post those invoices to the preceding month. However, I forgot it sometimes and posted them to the new month. When that happened, I had to make a list of those invoices and send it to the accountants to make accruals. This is what Accounts Payable Specialists usually do when they make similar mistakes.
After I entered invoices into the accounting system, I printed out batch summary reports and submitted them to my supervisor for her review. Most of the time, sending invoices batches to my boss was the last duty of my workdays, except for check run days. My supervisor was super detail-oriented. She could easily spot a bunch of mistakes within a five-minute review. If there was any mistake, I had to make corrections and reprint the batch reports again. If there was no mistake, I could relax for five to ten minutes before heading home.
Things got busier on the check run days. There were two days in a week when payments were made and applied to invoices. Payments can be made through ACH, wire transfer, or check. For ACH and wire payments, my supervisor was the only person who had access to the bank to set them up. Thus, my supervisor was responsible for setting up payments through wire and ACH, as well as applying those payments to corresponding invoices. For check payments, Accounts Payable Specialists took turns to print out the checks, create envelope labels, and mail out the checks. It took me at least one to two hours to do the check runs. I usually needed to work overtime on the check run days.
In addition to those daily tasks mentioned above, every two weeks, my teammates and I must spend some time sending out emails to vendors to request account statements, which listed open and paid invoices. My supervisor wanted us to review the statements thoroughly. We needed to go through all open invoices to see if we already processed them or at least received them. If not, we had to reach out to the vendors to request a copy of the invoices. My supervisor wanted to ensure that no invoices slipped through our fingers.
Besides, there was a small assignment that I occasionally did. When my company had new vendors, my job was to contact the vendors and ask for a copy of their W-9 forms. My supervisor then used the forms to create new vendor cards and vendor IDs in the accounting system for those vendors.
My most memorable experience was when the AP team had a meeting with the CFO. A week before the meeting, there was a blackout in the corporate office. The outage happened when the CFO was in the middle of an urgent meeting with several partners. Needless to say, the CFO was upset about the incident. The reason for the blackout was because one of the utility invoices were not paid in time. As a result, the CFO called a meeting of the entire AP team to discuss the event. My boss was also uncomfortable with this. Despite her caution and all the procedures in place, we still missed this invoice, and it was a big one. During the gathering, the CFO told us how critical our job was. He then asked each of us for solutions to prevent the incident from happening again in the future. The meeting ended with a free lunch for everybody. It was one of the most enjoyable moments for me at that company.
One thing that I learned from the incident is that Accounts Payable Specialists often gets all the blame when something wrong happens. There were many times when a few vendors sent their invoices late or worse. They completely forgot to forward the invoices. When the due date passed, the vendors automatically charged late fees. Some of them even stopped providing their service like in this case. In those situations, it was still the responsibility of the AP team to contact the vendors and ask for the invoices. This obligation is essential when it comes to utility bills and internet bills. In my opinion, utility providers are the worst at sending out invoices promptly. It may be because they know their service is vital, and everyone else has to play by their rules.
As can be seen, accounts payable specialist is all about data entry. If you don’t mind keying in invoice details all day long, this job is definitely for you. Thank you for reading my post.
Finding an optimal number of directors to sit on the board of a company is not an easy job in corporate governance. Generally speaking, both large boards and small boards have advantages and disadvantages. Large boards provide the diversity that can bring greater specialization to the board. However, this comes at a cost. Large boards increase compensation and agency costs. They also bring in communication and decision-making problems. Small boards, on the other hand, give better coordination between board members, but fewer ideas and skills among directors. Consequently, there is a trade-off between diversity and coordination when it comes to choosing between small and large boards.
Many studies have found that there is a relationship between board size and firm performance over the years. Nevertheless, the results are mixed. Some articles showed that the relationship between board size and firm performance is negative. In other words, those articles believed as board size gets bigger, firm performance goes down. For example, Yermack (1996) discovered that as board size goes up, Tobin’s Q as an estimate of market valuation goes down. Jensen (1993) concluded that companies should have a relatively small board to be effective in their monitoring. On the contrary, there were also studies in favor of large boards. The relationship between board size and firm performance is likely to be influenced by other factors, such as complexity. Complex firms might benefit from large boards (Coles, Daniel, and Naveen, 2008). In addition, Rechner and Dalton (1991) stated that stronger performance is connected with large boards. Finally, Connelly and Limpaphayom (2004) indicated that there is no correlation between board size and firm performance. As can be seen clearly, the findings are somewhat inconclusive. There have also been studies trying to determine the optimal board size. Lipton and Lorsch (1992) suggested that the number of directors should not exceed 10. Jensen (1993) proposed that the optimal number of directors should be 8.
It is noteworthy that firm performance also affects board size in corporate governance. When a company does not perform well, studies have concluded that preferences of the current board directors decide whether board size should increase or decrease. Tri-Valley Growers, which was a leading food processor in the US, raised the number of its directors from 11 to 13 when the company went through a restructuring in the 1990s after a period of bad performance. Conversely, Rice Growers Association, which was another company in the same industry, reduced the number of its directors from 25 to 15 to deal with the company’s financial crisis in 1986.
To conclude, the optimal number of directors sitting on the board of a company should depend on the company conditions. For small and medium-sized firms, board size should be small enough so that they can get the most out of board directors without having to pay the directors a fortune. On average, firms with annual revenues of $10 million or less have seven directors. For complex firms that have operations in different industries or countries, adding more directors with the right knowledge and expertise to the board will bring more benefits than the additional costs. On average, big firms with annual revenues of more than $10 million have 11 directors. Board size also depends on industry-specific. Adams and Mehran (2003) found that firms that are held by financial institutions have a larger board than firms in the manufacturing industry. Discovering the right number of directors is a trade-off between the advantages of having sufficient expertise and the additional costs of communication and compensation.
Corporate Governance: Board Diversity
Diversity on board of directors has attracted increasing attention in recent years. Spencer Stuart reported that the number of women sitting on the board in S&P 500 companies increased from 16% in 2004 to 19% in 2014, and the proportion of minorities has been 5% for the last couple of years. As in the case of board size, board diversity can bring both advantages and disadvantages. Diversity boards have access to a full pool of skills and knowledge. Furthermore, diversity also helps the board avoid groupthink problem and promote healthy debate. Having said that, diversity boards also bring some disadvantages to companies. First of all, women and minorities are often lack of managing experience. The primary way to become a board director is to have experience as a CEO of a corporation. Women and minorities have far less representation in top executive positions. According to Perma.cc, women only accounted for 3.5% of CEOs in Fortune 1000, and only 4.6% of CEOs in Fortune 500 are minorities. As a result, women and minorities often don’t have enough experience and knowledge when selected as board directors. In addition, the opinions of women and minorities are less likely to be heard equally because of tokenism. This creates information-sharing and communication problems.
With all the strengths and weaknesses of diversity boards in corporate governance, it’s not surprising that studies on this subject have provided mixed results. Luckerath-Rovers (2013) found that companies with high proportions of women and minorities performed better than those with lower proportions by 53% in ROE, 42% in ROS, and 66% in ROIC. Another study by Credit Suisse Research Institute in 2012 stated that the share price performance of companies that had annual revenues greater than $10 billion with female-male boards was 26% higher than comparable companies that had only male on their boards. On the contrary, Adams and Ferreira (2009) discovered a negative relationship between gender diversity and both ROA and Tobin’s Q. Hussein and Kiwia (2009) found no correlation between Tobin’s Q and female boards.
Given the benefits and drawbacks that diversity boards bring to companies, one should neither overestimate nor underestimate the role of diversity. In order to solve the problems that diversity may have on board, appropriate strategies need to be implemented on both individual and legal level. For individual strategies, mentoring and networking programs or leadership workshops should be held frequently to assist qualified applicants in choosing their career paths, improving their skills, building their resumes, and promoting them to corporate boards. The focus is to enhance the qualifications of women and minorities.
For legal strategies, the government should demand transparency around the process of searching for women and minority candidates. The government also needs to raise resources for anti-discrimination laws. If the government decided to impose quotas on board membership, consideration should be seriously taken as quotas can bring some problems, as in the case of Norway. Ditmar (2010) argued that an increasing number of Norwegian women had done little in improving firm performance. The shortage of qualified women has created the ‘golden skirts’ problem in Norway. Imposing quotas just simply translates into a rising number of unqualified directors. Researchers have introduced ‘comply-or-explain’ to address the problems of imposing quotas. Companies that are not able to meet the required proportions of women and minorities have to give reasons for the lower rates in their financial reports. More efforts need to be made in order for board diversity to progress further.
Corporate Governance: Board with Busy Directors
As with other board attributes in corporate governance, busy directors bring both benefits and drawbacks to the board. According to a survey by Equilar in 2013, the percentage of directors who serve on more than two boards is 15.3%, and that of more than three boards is 4.5%. While it is true that busy directors have less time to focus on one single board, one should not underestimate the benefits they bring to the firm. Busy directors are often talented and reputable directors. Because they are more experienced and more qualified directors, the demand for them is higher. It’s not surprising that they are busy. Furthermore, busy directors have broader social and professional connections, which can be beneficial to firms in many aspects. The question is whether the costs of recruiting busy directors are worth the benefits they bring.
Existing studies provided mixed results. Field, Lowry, and Mkrtchyan (2013) revealed that busy directors are linked with higher company valuations among IPO companies because they give better advisory services than other directors. Fama and Jensen (1983) suggested that busy directors are viewed as a certification of directors’ capabilities. On the contrary, Fich and Shivdasani (2006) stated that busy directors are connected with lower market-to-book ratios. Core, Holthausen, and Larcker (1999) concluded that excessive CEO pay and higher attendance issues at board meetings are connected with busy directors. Overall, the studies against multiple directorships found that busy directors are less productive when serving as monitors and advisers.
Despite the inconsistent results of empirical evidence, companies and shareholders tend to have a negative view of busy directors. A survey conducted in 2014 presented that the percentage of S&P 500 companies putting a restriction on the number of busy directors increased from 27% in 2006 to 74% in 2014. At the same time, the Institutional Shareholder Services (ISS) also suggests limitations on the number of busy directors.
The relationship between busy directors and firm performance is associated with the dual role of monitoring and advising in corporate governance. Busy directors are more effective in their advisory role because of their talents and experience but ineffective in their monitoring role because of their lack of time and dedication. Whether or not busy directors can bring benefits to a firm depends on what type of firm it is. For newly public firms, their managers have little experience in communicating with shareholders, analyzing market conditions as well as dealing with media. Board directors who can give valuable advice are really important. Busy directors, who have a lot of experience with those issues, can bring more benefits than costs for these firms. Besides, managers in newly public firms may own a high percentage of shares. It means their interests are likely to align with those of shareholders. The fact that busy directors have less time for their monitoring role is not really important for those companies. As it happens, the percentage of busy directors in IPO firms is 45%, and nearly half of IPO firms have busy directors (Field, Lowry, and Mkrtchyan, 2013). This proves that busy directors are beneficial to IPO firms. In contrast, busy directors may not be as helpful to mature firms as they are to IPO firms. For mature firms, independent directors and the board are already busy, adding more busy directors makes the problem worse. Nevertheless, some mature firms may have high growth opportunities and low agency problems. The benefits of busy directors of these firms may still outweigh the costs.
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Mobile banking and online banking are two different things. Nevertheless, they still have a lot in common. For reasons of convenience, I will use these two terms interchangeably in this post.
As more people have access to the internet and own a smartphone, a lot of mobile services have come into existence. People can now do a lot of things online, such as shopping (Amazon), ordering food (DoorDash), holding meetings (Zoom), etc. Among new digital services that are prevailing, mobile banking stands out as one of the most popular choices. Customers do not need to drive to a branch and wait in line. Instead, they can simply open the banking app on their smartphone and enjoy a wide array of services that online banking has to offer. Their financial life suddenly becomes a lot easier. They can bank in their own terms, whenever and wherever they want. Below is a list of services that people can take advantage of through online banking.
Opening new accounts: With online banking, opening new accounts is as easy as one-two-three. Different banks have different procedures regarding a new account opening. Generally, one just needs some necessary information (e.g., social security number, ID number, address) to have an account open.
Mobile deposits: This is probably the most significant advantage of mobile banking. Before the digital age, depositing checks requires people to go to a branch or an ATM machine. It is inconvenient, mainly when depositing checks is a repetitive task or when there are plenty of checks to be deposited. With mobile deposits, people can cash their checks right after they receive them. All they need to do is scanning their checks through the banking apps and enter some information.
Bank transfers: This service is useful for those who have accounts in different banks. External accounts that are owned by the same person can be easily added to mobile banking apps. Money can be moved between accounts freely at scheduled times. This service can also be used to send and receive money from friends and family. Besides, some banks even offer real-time ACH transfers. It means that money can be moved instantly between accounts at two different banks.
Bill payments: Nowadays, managing payments for recurring bills can be a challenge. On average, one person can have up to eight monthly bills. These bills include utility bills, phone bills, rent payments, etc. It is demanding to remember to pay them all on time to avoid late fees. Luckily, online banking can give assistance to all people who are in need. Most banking platforms offer a single location where payees can be added, and recurring payments are scheduled.
Building budgets: Most mobile banking apps allow customers to categorize their expenses and keep track of their spending. Furthermore, customers can sync their banking information with budgeting apps such as Mint or PocketGuard. It makes sticking to budgets painless and trouble-free. In addition, customers can set goals to help them recognize what they are saving for, track their progress, and mark their achievements. They can do all of these things in the palm of their hand.
Access money: Mobile banking enables customers to connect their debit cards with wallet apps such as Apple Pay and Google Pay. These wallet apps permit people to store the virtual version of their ATM/debit/credit cards. The apps can be used to make contactless payments in stores as well as online payments.
Currently, both brick-and-mortar banks (e.g., Chase, CitiBank) and online-only banks (Ally, CapitalOne) offer online banking. While a lot of people still favor brick-and-mortar banks due to their credibility, online-only banks certainly have their place when it comes to fees. Giant banks, such as Chase or Bank of America, charge all kinds of fees, from monthly maintenance fees to overdraft fees. It is not easy to keep an account open at big banks for low-income people or those who do not have a job. Online-only banks, on the other hand, are mostly free. They do not charge their customers anything. For example, I have a checking and savings account with Chime for years, and I have never been charged anything. Online banks also offer higher interest rates for savings accounts and CDs. Not having physical branches certainly helps those online-only banks. They do not incur expenses that brick-and-mortar banks must pay. Thus, digital banks can keep their fees zero or close to zero. Another thing is that if online banks started charging fees, no one would use them. Zero fees, higher interest rates, and better customer service, to some extent, are their only advantages.
The main disadvantage of online banks is, of course, the lack of physical branches. This becomes a big problem in urgent situations that involve large amounts of funds. What if someone sends you a big lump sum of money, and it has not gone through your account? You would probably prefer speaking to someone about this in-person to over the phone. Also, when there are problems, it is more satisfying walking to a branch and complaining face to face.
For me, I am using both brick-and-mortar banks and online banks to have the best of both worlds. For brick-and-mortar banks, I am using Chase and U.S. Bank. I use Chase mostly for convenience purposes. This bank has branches everywhere. There are two Chase branches within two miles where I live! For U.S. Bank, I have been using it forever. I have several credit cards with U.S. Bank, so I am eligible for its gold checking package. I do not have to pay monthly fees for checking and savings account.
For online banks, I am using Chime. I really like this bank for several reasons. First, its mobile banking app is intuitive and user-friendly. Second, as with other digital banks, Chime does not charge any fees. The bank claims on its website that it has no hidden fees. Third, it offers automatic savings. Whenever you spend money, the paid amount is rounded up to the nearest dollar. That round-up is automatically transferred from checking to savings accounts. Finally, if you set up direct deposits to Chime accounts, the funds arrive two days early. It is super cool to have the money available to you two days early, especially when you need to make urgent purchases.
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There are different leadership styles. Each style can have a unique influence on a company’s performance and effectiveness. It is because leadership styles can influence employees’ satisfaction and trust. In general, leadership styles can be divided into three major categories. They are autocratic, democratic, and laissez-faire leadership. There is no best leadership style. They all have their strengths and weaknesses. Depending on the situation, some styles are more appropriate than others.
For autocratic style, the leaders make almost all of the decisions, leaving little room for employee’s involvement in the decision-making process. The leaders often ignore suggestions from employees. The main advantage of this leadership style is when time is at essence. Specific tasks must be completed immediately. In those situations, autocratic leadership helps leaders save time and get the jobs done as quickly as possible. The major disadvantage of this leadership style is that it limits the creativity and motivation of the entire organization. Employees have no incentives to think creatively because they know that their opinions will not be heard.
Under the democratic leadership, some decision-making authority is given to employees. However, the leaders still reserve the right to make final decisions. The advantage of this style is that employees would be more motivated as they feel their opinions matter more. Consequently, they are more likely to contribute more. The disadvantage is that it takes longer to make decisions as the leaders have to take imputes from employees.
Regarding the laissez-faire leadership style, the decision-making controls are completely given to the employees. The leaders do not control what employees are doing. The convenience of this leadership style is that it works well when the employees are independent and self-motivated. It does not work well when employees rely on leaders to give them guidance.
This post mainly focuses on the comparison between autocratic and democratic styles. For the autocratic style, Elon Musk is chosen as an example. He is the founder of Tesla Motors. He is well-known not only because of his achievements, but also his way of leading and thinking. For the democratic style, Tim Cook is chosen. Most people know he is the CEO of Apple, which is a multinational technology company.
Leadership Style: Leadership Effectiveness
Typically, there are five main characteristics of an effective leader. First, effective leaders must be trustworthy. When followers put trust in their leader, the leader can influence the followers’ actions and career paths. In addition, effective leaders should be honest. For a leader to be trustworthy, he or she has to be honest first. The leader has to practice ethical and legal behaviors. Second, an effective leader has to be strategic. In other words, the leader is required to act and think strategically. It is because the leader is accountable for forming the future of his or her organization. The leader must possess strategic perspective to guide their followers to the future.
Third, an effective leader is under an obligation to understand and illustrate the importance of teamwork. By definition, leaders only exist when individuals of an organization come together and act as a body. Thus, without teamwork, there would be no organization and no leaders. An effective leader must know how to bring people together to work towards reaching the desired goals. Furthermore, not only the leader needs to create teamwork, he or she also needs to create synergy among members to achieve higher results.
Fourth, leaders should know how to allocate time and energy logically. In reality, a leader cannot be everywhere at the same time. To appear in the proper place at the correct time, an effective leader should acquire skills to distribute his or her time and energy appropriately. The fifth characteristic that an effective leader must have is the ability to identify roles and relationships. The role of each team member has to be defined clearly by the leader and what they should do to contribute to the team relationship as a whole. A winning team is a team whose every member knows the fundamentals of their role and how to play his or her position.
For Elon Musk, there are several things that are mentioned above, making him an effective leader. First, he focuses on people and teamwork. He paid his employees high enough so that they could afford the cars they built. Because of this, all the talents in the region and the world wanted to work for him and his company had a really low turnover rate. Musk always made his employees feel appreciated. He showed that he valued each employee in the company. As can be seen, he attracted talents by both salary and recognition. In addition, Elon Musk always believed in himself and made his employees believe in themselves as well. He wanted to be surrounded by people who thought like him. It was why he hired people who would like to go over their limits.
As a democratic leader, Tim Cook pays close attention to the people who talk to him. Because of this, Cook is able to understand his employees well, their goals, and how to deliver them. Another thing that makes Tim Cook an effective leader is that he puts trust in other people. Cook has been lucky enough to be surrounded by top people who can share the workload with him. He understands that he could not handle everything. He puts trust in the top talented people and shares his work with them. This makes him more effective as a leader. Another thing that makes Tim Cook an effective leader is that he is willing to admit when he is wrong. In fact, he said in an interview that having the courage to change his mind is one thing that Cook admires the most from Steve Jobs. Finally, being transparent is what makes Tim Cook effective leadership lasts. He once said that transparency is the foundation of a leader. If something does not work, people can see from the outside and give Cook suggestions to fix those things. As it shows, while Elon Musk became an effective leader by making his employees believe in themselves while Tim Cook is open to suggestions and is not afraid of being wrong.
Leadership Style: Increasing Motivation
Studies have shown that motivated employees are one of the most significant outcomes of effective leaders. Achieving the company’s goals is not sufficient to keep employees motivated. In fact, effective leaders need to help employees to achieve their own personal goals to motivate them. The more motivated the employees, the more effective the leaders can be.
There are several ways that leaders can use to increase the motivation of employees. First, effective leaders have to commit to making employees happy. Studies have shown that productivity can increase up to twenty percent when employees feel happy, welcomed, and that companies offer great benefits. From then on, the employees are motivated to contribute to the company. Second, to motivate employees, leaders have to give them chances to speak up their minds. Effective leaders must show they are open to feedback and leave room for improvements. When the employees feel their voice is heard, they become more motivated. Third, effective leaders need to set up examples that are worth it for employees to follow. The examples can range from how to compose emails to give presentations. When the leaders demonstrate good examples that employees want to follow, they give their employees the motivation to improve themselves by following the leader’s leads.
For Elon Musk, he was always motivated to do what was beyond his abilities. He was a person who did not take a task because he was capable of doing it. He took the task because he viewed it as an opportunity to learn. In his life, Musk failed multiple times. However, he was not discouraged by his failures. Instead, he took the failures as lessons for his future success. This way of thinking inspired other people. Musk’s employees were inspired by him. Even though Musk followed the autocratic leadership style, his employees still felt inspired by his way of thinking and how he was willing to take on challenges to test his abilities.
One way that Tim Cook motivates his employees is to make an effort to appreciate their work. He once said that every employee helped make Apple grow. Thus, everyone got rewarded. For example, last Thanksgiving, he extended the number of paid holidays. He did not see this as an expense but rather an investment. Furthermore, there are many times that Tim Cook thanked his employees in front of the public. For example, after the release of the iPhone X, Tim Cook publicly thanked his iPhone team. He said that his team executed an outstanding product that required years of experiment and development.
How Elon Musk and Tim Cook Will be Remembered in Business History
Elon Musk has always been remembered as a transformational autocratic leader. Even though he had complete control of his company, he gave his employees the motivation to accomplish their targets and tasks through his characteristics. He was also a man with a wonderful vision. He had the power to create new things, which were unthinkable by other people. He was convinced that his way of thinking would lead his company to success, and he was right. He was confident in his ability and decisions and those made him a great leader. His leadership style suited well with the auto industry, which required bold decisions and innovations to gain a competitive advantage over other opponents.
One thing that Tim Cook is remembered as a leader in business history is his persistence in pursuing his core values and beliefs. Even though a lot of people are against Tim Cook’s philosophy, he accepts the risk and follows his own values and beliefs. This is what faithful leadership belongs to and this is what he will be remembered. Moreover, Cook is recognized as a leader whose commitment to bringing him sincerely and genuinely to all aspects of life. It shows that authentic leadership is based upon the aligned quest of the leader’s legacy. It is the truth and trust that helps him have great relationships with people.
Leadership Style: Communications to Support Ideas
Accurate communication is an essential component to become an effective leader. It is good communication skills that make leaders successful. Effective leaders are capable of connecting their passions while communicating their ideas with others. There are some techniques that effective leaders use for communications to support their ideas. First of all, effective leaders keep their messages inspiring yet straightforward and carry deep meaning. They are able to connect their messages with employees’ jobs, beliefs, and goals. Second, effective leaders usually convey their ideas through stories. Employees do not remember facts and figures. It is real-life stories and experiences that make the ideas relevant and memorable to employees. Lastly, effective leaders can show authenticity in their messages. Because of this, it is easier for effective leaders to communicate their ideas to others.
In the case of Elon Musk, he concentrated heavily on internal communications. To him, internal communications are important in the manufacturing industry. One technique that Musk used to support his ideas was avoiding technology terms. As mentioned above, Musk preferred to keep his ideas simple so that they could be remembered by people more easily. Another technique that Musk used was to communicate through all levels of his company. Even though he was an autocratic leader, he still created an environment where his employees felt safe to give feedback when Musk communicated his ideas to them.
Similar to Elon Musk, Tim Cook has an excellent way of communicating his ideas to his employees. In an interview with Forbes, Cook was able to explain the entire Apple’s operations within ninety seconds. He clearly explained the essential parts of Apple’s business. Furthermore, in all of his speeches, he keeps his focus on customers. He uses examples of people’s lives to highlight Apple’s products. This is what makes his communications inspiring and memorable to the majority of his audience.
Techniques for Problem-Solving, Generating Solutions, and Decision Making
One technique that Elon Musk used to solve problems and generate solutions was to stay focus. To him, people are not aware of their potential. If they focus all of their efforts on the job they are doing, no matter how hard the job is, they can potentially finish it. Also, he once said that there was no hard problem. In his opinion, a hard problem is just a collection of multiple small and easy problems. If a person is persistent enough, all hard problems can be solved. It is just like climbing a mountain. A person needs to climb one step at a time.
In contrast, when approaching problems, the first thing Tim Cook does is to stay calm. Despite the fact that Apple operates at a really fast pace, his calmness helps him get rid of confusion and incompetence when dealing with critical problems. Besides, he always reminds Apple’s employees of the company’s values and asks them to use the values as their guides when solving problems. If there were problems, they must be attacked aggressively.
To conclude, there are different types of leadership, ranging from autocratic to laissez-faire. Each type brings with them their own advantages and disadvantages. Great leaders in the business industry follow different types of leadership based on their personal beliefs, values, personalities, and preferences. In this post, Elon Musk is chosen as a representative for the autocratic leadership style and Tim Cook as a representative for the democratic leadership style. While Elon Musk takes all the power of making decisions to himself, Tim Cook pays more attention to fostering his relationships with employees. In terms of motivations, Elon Musk motivates his employees through being their role models and making them believe in themselves. In contrast, Tim Cook provides rewards and recognition to his employees to motivate them. Both Tim Cook and Elon Musk are great leaders and will be remembered in the business industry. However, while Elson Musk will be remembered as a leader who makes bold decisions and takes on challenges, Tim Cook will be remembered as a leader who follows his own values and beliefs persistently. Their leadership styles and skills are great examples of how a true leader is, regardless of leadership styles.
When it comes to emerging markets, Amazon did make several right decisions in terms of its entry strategies. Before it entered the Indian market, Amazon had nearly a decade studying Indian costumers’ preferences based on various factors (e.g., age, location, gender) through their website Junglee.com. The knowledge that Amazon gathered was useful to the company in developing its strategies. Not only Amazon was able to learn from its customers, but also its main competitors. Because Amazon entered the Indian market relatively late compared to its main competitors, Amazon was able to learn from the mistakes of its competitors. These reasons explain why Amazon decided to invest big right from the start rather than making piecemeal investments. Due to Amazon’s inability to sell its own products in India as what it has been doing in the US, entering the Indian market sooner would not have made Amazon gain any advantages. In fact, Amazon could have encountered some disadvantages if it would have entered the Indian market sooner. The company would not have been able to learn from the customers as well as its competitors. After entering the Indian market, Amazon quickly built its own distribution network as well as differentiated itself from its competitors. Since Amazon can only function as a marketplace, these strategies have allowed it to maximize its share of the Indian market.
In the case of China, Amazon made a smart move into the Chinese market. By acquiring Joyo.com for $75 million, which is a relatively low price, Amazon was able to gain access to one of the best growth areas geographically. However, Amazon’s investment in China has not paid off as it did in other emerging markets. Until 2013, the Chinese e-commerce market was dominated by Alibaba, and Amazon was only able to hold a one percent share of this market. To improve its situation in China, Amazon launched its Kindle e-reader in China in June 2013. Amazon should have launched its Kindle earlier. Amazon’s Kindle was undoubtedly a pioneer in the e-book industry in the US. However, by the time Amazon launched its Kindle, the Chinese market was crowded. At that time, some of Amazon’s competitors had a larger number of Chinese-language books than Amazon’s Kindle Store. Furthermore, Chinese customers could read Kindle books using the Kindle app on their Apple or Android devices. All these factors made it harder for Amazon to increase its share in the Chinese market. With respect to the logistics operation, Amazon’s strategy was sensible. When Amazon entered China, the logistics service in China was immature. Amazon made a smart choice by establishing a delivery team of its own. Amazon employed drivers who make deliveries using their own vehicles (e.g., bicycles, motorcycles, and scooters). Because of this, Amazon has been able to deliver fast and fulfill orders on special occasions (holidays, New Year, etc.). Nevertheless, Amazon still faced fierce competition. Its competitors have also invested in their contribution networks. Amazon is not really successful in China, and it needs to differentiate itself furthermore to be able to increase its share in the Chinese market.
In the case of Brazil, which is another emerging markets, Amazon’s choices were reasonable as well. Until 2014, Amazon was able to hold a sixty percent share of Brazil’s digital market. Amazon first entered Brazil by introducing Kindle Store in spite of Brazil’s corrupt bureaucracy, poor service, and infrastructure. By doing this, Amazon was able to minimize the risks and claim its share in Brazil’s market. Because of the bad infrastructure, Amazon has outsourced its logistics to local companies. Although Amazon could avoid all the risks and costs by leaving logistics to its Brazil partners, its delivery time is longer than that of Saraiva, which is one of its main competitors. Amazon should decrease its delivery time to improve its competitive advantage. Another smart move by Amazon is that it has not offered big publisher discounts. The company’s current discount rate is lower than that of other competitors. Amazon has not been really demanding in its discount negotiation for acquiring books from Brazilian publishers. This strategy has enabled Amazon to formalize contracts with over thirty publishers.
Some people may ask whether Amazon should enter additional emerging markets immediately. The answer to this question depends on those markets’ conditions and how well Amazon understands those markets. Amazon should pay more attention to Southeast Asia. Like in Vietnam, the demand for e-book increases with the need for Amazon’s Kindles. Yet, it is challenging to buy e-books directly from Amazon in Vietnam. Vietnamese customers have to buy e-books from third parties and go through a complicated process. The demand for e-books and Amazon products is high not just in Vietnam, but also in other Southeast Asian countries. China has influenced Vietnam and other Asian countries for a really long period of time. Therefore, customers’ preference based on age, gender, or location in Southeast Asia is somewhat similar to that of China. Amazon could take advantage of this when it enters the Southeast Asian market.
Besides, it’s not sustainable for Amazon to simultaneously pursuit geographic, horizontal, and vertical expansion in emerging markets. The horizontal expansion means providing similar products or services in different locations. This is costly to Amazon since different locations have different types of economic conditions, lifestyles, or populations. The vertical expansion means providing a broader range of products or services in one location. This kind of expansion is more useful to Amazon since, in some countries (like China and India), it’s not really successful. By broaden its products or services to customers, it may be able to differentiate itself from its chief competitors. In terms of geographic expansion, it is necessary that Amazon should pursuit this kind of expansion. As said earlier, Southeast Asian countries are in high demand for Amazon’s e-books and Kindles. If Amazon does not enter these markets soon, other companies may take over (e.g., Alibaba already launched its Taobao service in Singapore). To sum up, it is not useful for Amazon to pursuit geographic, horizontal, and vertical expansion at the same time. Instead, it should focus on strengthen its business in some countries that it has not been really successful by vertical expansion and enter new potential markets before its competitors take over by geographic expansion.
Export restrictions (such as export tax) are not uncommon among countries. There are many reasons why countries may want to impose export restrictions. One of the reasons can be the difference between domestic supplies and the demands of certain goods. For instance, during the food crisis from 2007 to 2008, several developing countries imposed export restrictions on their agricultural commodities to raise their food security. Another reason can be that the governments want to support high-value manufacturing industries. By imposing export taxes on unprocessed materials that are used as inputs to produce higher-value goods, the governments can lower the domestic prices of unprocessed materials and indirectly subsidized higher-value industries. Furthermore, imposing export tax raises revenues for the governments. In other words, governments can use export tax as a source of funds to do other things.
Besides the above reasons, if a country that imposes export taxes is a large country, it can influence the world price. If a large country feels that the world price is not high enough and wants to improve its terms of trade, it may impose export taxes to reduce the number of goods being exported to the world and increase the world price. Lastly, export taxes are useful to fight domestic inflation. When tax is imposed on exports, the domestic prices of those exports will fall. The price decreases can help the governments relieve the effect of high inflation.
There are several downsides to the export restrictions. One of the downsides is that export taxes hurt producers who export their goods to foreign countries. Export tax can reduce the domestic producers’ competitive advantages, thus, put them in difficult situations. Another drawback of export taxes is that the tax reduces the foreign-exchange reserves. This will create difficulties for the governments to pay back foreign debts or import foreign goods.
Before going into the analysis of the impact of export tax on consumers, producers, and the public in small and large countries, it is important to understand the concepts of consumer surplus and producer surplus. Consumer surplus can be understood as a measure of the welfare that consumers get from buying commodities. It is computed by subtracting what the consumers actually paid from what they are willing to pay. Producer surplus is an indication of the welfare that producers get from selling the commodities. It is computed by subtracting the price that consumers would accept to produce the commodities from what they actually took from selling the goods.
Export Taxes in a Small Country
Suppose the initial domestic price is P0 and equal to the world price PW. At the initial price P0, the small country’s domestic supply S0 is greater than its domestic demand D0. As a result, the difference between domestic supply and demand is exported to foreign countries at the price PW.
When the small country’s government imposes taxes on the exports, domestic producers will prefer the domestic market because it is untaxed. Thus, domestic supply will increase, and domestic prices will decrease. The domestic price will keep decreasing until it reaches P1 = PW x (1 – t). Because it is a small country, the world price is not influenced by the export tax and remains unchanged. When the domestic price reaches the world price minus the export tax, the producers will be indifferent between selling to the domestic market and exporting to foreign countries.
Domestic consumers gain the benefits from the tax because they enjoy a greater amount of goods (D1 > D0) at a lower price. The consumer surplus increases by area a. The producers suffer because they produce less (X1 < X0) and sell at a lower price (P1 < P0). The producer surplus decreases by areas (a + b + c + d). Finally, the government also gains from the export tax by getting the revenue equal to the area c. The end result is a loss of domestic welfare, which is the area (b + d).
As it shows, the export tax redistributes welfare from domestic to the government and domestic consumers. However, the overall national welfare is lower. Thus, the governments in small countries should not impose the export tax, assuming $1 of consumer surplus is the same as $1 of producer surplus and $1 of public revenues.
Having said that, small countries may still want to consider the use of tax under certain circumstances. For example, if a small country is suffering from food scarcity, it should impose export taxes on food products to secure the food supplies and stabilize food prices.
Large Country Case
In the case of a large country, the world price is affected by the export tax. This is built on the speculation that the large country accounts for a big share of goods that are exported to the global market. When the large country imposes an export tax on the exports, the number of exports in the world market will decrease. Thus, the world price of exports will go up.
The effect of this kind of export restriction on consumers is the same as the effect in the small country’s case. The domestic price will decrease from P0 to P1 and demand will increase from D0 to D1. Because the consumers enjoy more goods at a lower price, the consumer surplus expands by the area a. Similarly, the effect of export tax on producers is also the same as in the small country’s case. Because the producers sell fewer goods at a lower price, the producer surplus shrinks by the areas (a + b + c + d).
For the government’s revenues, they are different from the small country’s case because of the increase in the world price. The government’s revenues rise by the area (c + e) in this case. If the area e is greater than areas (b + d), the total domestic welfare will increase because of the export tax. Areas (b +d) indicate domestic welfare losses from the tax while area e indicates the increase in terms of trade. Before the imposition of export tax, each unit that is exported is traded at the price PW in the world market. After the imposition of taxes, the units (X1 – D1) are now traded at a higher price PW1 in the world market. Thus, the terms of trade increase by the difference between PW and PW1.
Symptoms of Resistance to Change
in change management, resistance to change can be visible or invisible. Higher gossip around the coffee points about the changes, lower morale, and productivity can be the signs of invisible resistance. In contrast, open debates are one obvious sign of visible resistance. A visible resistance is more beneficial to organizational changes than an invisible one. It is because open resistance may give challenges and constructive feedback to the changes. Besides, resistance can also be categorized into active and passive resistance. Symptoms of active resistance include being critical, spreading rumors, looking for fault, threatening, blaming, etc. Passive resistance’s symptoms include procrastinating, unfollowing the changes even though agreeing in person, withholding information, etc.
Throughout this post, I will include what I experienced at one of the companies that I used to work for as examples. I think it can illustrate my points here. For simplicity’s sake, I will refer to that company as “my company”. During 2017, my company was audited by Deloitte. Because the company had undergone a significant change in its accounting software program in 2016, there were a lot of issues with the systems, financial reports, internal control, etc. Deloitte pointed out those problems. They refused to give my company an audit clearance. Without an audit clearance, my company could not issue financial reports to its shareholder. My company was owned 100% by a big multinational firm headquartered in Tokyo, Japan. Thus, that big international firm was the sole shareholder of my company.
Under pressure from the parent company, my company’s CEO and CFO made some quick and profound changes in 2017. One of the most important changes was limiting access to the accounting software based on the corporate hierarchy. It meant that the controller had more access to the system than the accounting manager. The managers had more access than employees. This change was to fix the internal control problem. Before the change, everyone had full access to the system regardless of who they were. Despite the fact that the change improved internal control, it slowed down the workflow. It made the workflow more complicated and time-consuming. The passive form of resistance I observed from this change was the rumors among the employees. The rumors said that the controller wanted to control everything, even though he did not have the knowledge about the things that he wanted to control. The change was for his own satisfaction. Although no one stood up and criticized the change, the overall morale among employees was low. The employees were not happy because their full access to the system was revoked. They also had to spend more time getting their tasks done.
In terms of an active form of resistance to change, there was another change that was also made in 2017 by the CEO and CFO. This change was about the separation of duties between the tax department and the accounting department. The new accounting software did not capture sales tax when the billing department issued sales invoices to customers. The sales tax portions were not calculated, and sales tax accounts were not reconciled. Before 2017, the old accounting software automatically calculated everything. The CFO called the tax manager in for a meeting and demanded that the tax department be responsible for calculating sales tax and reconciling sales tax accounts. The tax manager did not agree. He argued that his department should not be responsible for reconciling the tax accounts. That should be the responsibility of the accounting department. The tax manager also criticized the accounting system for its failure to calculate sales tax. This is the symptom of active resistance that I experienced in my company.
Reasons for Resisting Changes
There are five main reasons why staff members have resistance to change. The first reason is that people are afraid of the unknown or surprise. This reason exists because changes are made without warnings or heads-up from the change managers. When organizational changes are implemented without signs or giving people more information about what the changes include and how the changes affect their jobs, people tend to push back the changes due to the distress of the unknown. The second reason for change resisting is the distrust in change managers. If the change managers are respectable among employees, employees are more likely to accept the changes than if the change managers are new and disreputable. It takes time for managers to win trust from employees.
The third reason is bad timing. In change management, if changes are implemented in a short period of time or at the wrong time, employees are more likely to resist the changes. I experienced this reason for resisting change at my company. In March 2018, the CFO decided to change the allocation rules. Because my company operated in different regions throughout the U.S., corporate overhead costs had to be allocated to all regions in order to calculate the bonuses for regional sales managers. The change was not big. However, March 2018 was the busiest time for the accounting department because it was the time when the fiscal year 2017 ended. For those who don’t know, in Japan, the financial starts from April 1st to March 31st. Even though the change was small and reasonable, accounting employees were not happy about it. This is something that change management needs to consider.
The fourth reason is people’s perceptions of changes. Different people feel differently about the changes. Some people feel they may end up being worse after the changes than the others (e.g., losing jobs, being moved to a lower position). Therefore, they are less likely to support the changes and develop resistance to change. In addition, some people may feel excited because changes are opportunities for them to learn new things. Thus, they support the changes. People who prefer routine tasks are more resistant to the changes. The fifth reason concerns the incentives and rewards of the changes. If the benefits of the changes are not worth the troubles involved, there is more chance people will resist the changes. Besides those reasons listed above, there are also other less common reasons for resisting changes. For example, people may not like the changes because they are afraid that they have to acquire new skills to adapt to the changes. Another reason can be that previous changes ended up failing. Thus, people will think these upcoming changes are no different and unnecessary. Finally, the company’s culture can be the reason for resisting changes. If employees feel attached to the company’s culture, they will resist new changes more than employees who feel less attached.
Depending on the companies, the “top three” reasons for resisting changes may vary regarding change management. There are three questions that a change manager should ask in order to identify what reasons for resisting changes are the most common among the majority of employees. The first question is what the changes include. If the changes are related to combining different positions into one and making several employees redundant, the most common reason for resisting changes among employees is more likely the fear that they will lose their jobs. If the changes involve upgrading the information system, the most common reason can be the fear of learning new skills.
The second reason the change manager should ask is who the changes will affect. If the changes only affect certain people in the company, the reason for resisting changes may restrict within that group only. The final question the change manager should ask is how the changes will affect employees. If the changes positively affect employees (e.g., shorten the time they do things, less work), there may not be any resistance at all. In my experience mentioned above, even though the changes enhance the internal control of my company, they make routine tasks more time-consuming, thus, create resistance among employees.
With regard to the most difficult reasons to deal with from a change manager’s perspective, it also depends on the company and the changes when asking the three questions mentioned above. For the first question, which is what changes include, if the changes include learning new computer skills and there are a lot of old employees who do not like to learn new skills in the company, this will be the most difficult reason for resisting change to deal with as a change manager. Providing training and creating clear and easy-to-understand computer guidance can help ease the change management process.
For the second question, which is whom the changes have impacts on, if the changes affect only one or two departments, the employees (both affected and unaffected by the changes) may think there is discrimination against them. This feeling of discrimination can create resistance to change. In this case, transparent and timely communications from managers can smooth out the process when it comes to change management. Lastly, for the question that asks how the changes affect employees, the challenge for change managers is that the goals of employees do not align with the goals of the company. For instance, if the changes are to make the company more profitable but more work for the employees, they will naturally resist the changes because their goals may not be the same. In this case, change managers can align the goals of the company with those of employees by rewarding the employees. If one percent of the company’s profit is used to reward employees, the employees will have the incentives to embrace the changes.
As mentioned in the previous example, the tax manager in my company actively resisted the changes. Because of the changes, his department had to work more to reconcile all tax accounts that had never been reconciled before. In addition, to tighten internal control, the tax manager had to report to the controller for tax payments that were greater than a certain threshold. The changes obviously decreased the impact of his role in the company. He did not have the freedom he once had when it came to filing tax returns and making tax payments.
There are several methods that companies can stop senior managers from resisting changes in change management. First of all, change leaders should consult senior managers in the early stage of the decision-making process. Informing them of all the problems, what the changes are for, and their feedback on the changes are necessary. In my example, the tax manager should have been asked about the tax account reconciliation problems and his suggestions on solving the issues. After all, he is the most crucial change agent when implementing the changes. Second, the senior managers should be given enough tools, resources, and time to implement the changes. Sometimes, senior managers oppose the changes because they feel they do not have all the necessary resources to make the changes happen. The tax manager at my company could have been supportive of the changes if he had been given more resources (e.g., hire more employees for the tax department, hire outside consultants). Finally, supports from change leaders are essential. If senior managers feel that their leaders are in favor of what they are doing, they will be less likely to resist the changes.
Managing Change Resistance
There are different approaches to managing resistance with respect to change management. The first approach is the attraction approach. Under this approach, people resist because they find the old system attractive. The tasks of change leaders are to find new attractors that can attract people to the new system. In order to create attractors, change leaders need to work together with the employees and have a close and trust relationship with them. There are several questions the change leaders can use to identify attractors (e.g. How will the changes benefit the employees? How do the changes relate to their interest? How to improve performance?) The bottom line is that resistance can be avoided if the change leaders make those who involve in the change process feel appealing to the changes.
Another approach is the contingency approach. Under this approach, there is no best way to handle resistance. People have different reasons why they resist changes. Thus, they need to be handled differently. There are diverse strategies to manage resistance. Depending on the situation, appropriate strategies can be used to manage resistance. In my company, the approach used was the attraction approach. The change leaders (the CEO and CFO) appealed employees to the changes by identifying attractors. For instance, there were emails to employees to inform them of new features of the latest IT system that would be implemented in July 2018. The emails said that the new IT system would be faster and would help employees shorten their work times.
There are a large number of interpretations of corporate social responsibility (CSR). One popular definition is that CSR as business practices that aim at social and environmental issues, including pollution, inequality, public health, etc. Companies that adopt CSR practices have higher operational performance and a greater level of sustainability. Similarly, another definition views CSR as a voluntary business plan that is incorporated into a company’s strategy to address social concerns. There are several benefits of CSR, including higher employee morale, better customer satisfaction, and brand recognition, greater cost-saving, and easier access to capital. With those benefits, more and more companies have integrated CSR practices into their daily operations. Cisco Systems, Inc. is one of those companies that not only have a CSR program in place but also prioritize corporate social responsibility practices in their business agendas.
Founded in 1984 and headquartered in Silicon Valley in California, Cisco Systems, Inc. is one of the biggest technology firms in the U.S. The company specializes in manufacturing high-technology devices such as telecommunications equipment and networking hardware. Its mission is to connect people and computers through its networking solutions, enabling them to exchange information, regardless of their time and location differences. Cisco’s corporate social responsibility philosophy is building bridges between hopes and possibilities. The company has been using its technology and resources to solve global problems and achieve social benefits as well as environmental sustainability. The CSR programs at Cisco are managed by Corporate Affairs, which is a part of the company’s Human Resources department. Corporate Affairs has four major responsibilities regarding CSR. The four responsibilities are defining and managing CSR programs, driving CSR processes, communicating with stakeholders, and evaluating and monitoring corporate social responsibility issues. Some CSR campaigns are initiated by various business functions within the company. Other campaigns are owned by Corporate Affairs. All are incorporated into ongoing and long-term business plans that focus on social and environmental impacts.
Cisco measures the success of its corporate social responsibility by how it positively affects society. Every year, Cisco projects a set of goals of what its impact will be on society for the entire year. At the end of the year, the set of goals is used as an indication of whether the company has been successful in its CSR campaigns. For example, in 2019, the company set four main CSR goals. The first goal was for Cisco Networking Academy, which offers free online courses for IT entrepreneurs, to reach two million students. The second goal was to keep away one million metric tons of greenhouse gas emissions in the company’s supply chain. The third goal was to achieve at least eighty percent of community involvement through employees’ participation. Employees’ participation can be anything from donating, volunteering to advocate for the causes that the employees care about. The last goal was to positively influence one billion people through the company’s Global Impact Cash Grants program by 2025.
For the first goal of its corporate social responsibility, Cisco Networking Academy was able to reach 2.15 million students in 2019. The students come from all countries around the world. It is promised that this number will continue to grow in the coming years with the help of Cisco’s new partnerships. For the second goal, Cisco managed to exceed the expectations ahead of the 2020 target date. All of the company’s electricity used in the U.S. and Canada facilities is generated by renewable energy. For the third goal, Cisco failed to meet its target. Employee engagement was stopped at fifty-one percent, which was far below its target level at eighty percent. Cisco admitted its failure for this goal and promised to adjust its plans to get a more favorable result. For the last goal, as of 2019, the company impacted approximately 470 million people. If everything is kept at this rate, Cisco will be able to reach its goal ahead of 2025.
As can be seen, the corporate social responsibility programs of Cisco are sustainable because the goals are either long-term of repetitive annually. Furthermore, the CSR goals address the current concerns of the society. Those concerns are how to use technology to develop and protect the environment. Lastly, CSR programs have measurable results. Thus, Cisco can evaluate its programs and make adjustments if necessary.
Corporate social responsibility has become more and more important to businesses around the globe to boost their brand recognition as well as gain competitive advantages. Cisco Systems, Inc. is not an exception. The executives at Cisco have long understood that CSR must be a vital part of a sustainable business. It is the reason the company established its own Corporate Affairs who oversees all CSR programs of the company. Through its CSR practices, Cisco has successfully built its business image, retained best talents, and created its own competitive advantages. All of these have made a big contribution to the overall success of the company.