Hanging on a Wire: 20 years and STILL….
August 2000: Enron shares hit an all time high of $90.56. By December 2001 they had filed for Bankruptcy protection. Over the next 3 years their employees lost their jobs and pensions, some of the management went to prison, and their Auditor (who had signed off the accounts) went out of business themselves.
September 2020: Wirecard. Their shares have hit highs, they have filed for bankruptcy protection, employees have lost jobs, some of their management are out on bail or (allegedly) on the run. And their Auditor is still in business and Auditing, but questions are being asked.
The Wirecard scandal has some similarities with what happened 20 years ago – also some differences, but it is the similarities that strike me.
The good news stories that preceded the fall, the importance of “whistle-blowers”, the connections with the political world. The role of the Auditor.
Finance in some ways is just human behaviour showing up on a spreadsheet. Alongside big money comes temptation, some people succumb. You would have thought we would have learned that by now?
In the wake of some excellent investigative journalism by the Financial Times, in time there will no doubt be a suitably good book, or books, coming along.
For now, 3 – or maybe 4, reflections:
1) Auditors: often seen as a necessary evil, now seen as maybe not evil enough, and not looking hard enough at the basic figures. Enron brought its Auditor (Andersen) down with it. EY should do better, despite its recent fine. The auditing profession is undergoing a change of regulator in the UK from FRC to AGA. There is a long list of corporate “issues” with “clean” audit statements attached – BHS, Carillion, Goals Soccer Centres, Conviviality – and that is just the UK. The role and scope of audit is ripe for discussion and renewal.
2) Who can you trust? The people running Wirecard looked like sensible, normal people you would happily live next to. They were trusted by some of the most senior levels of government and lauded in the press. But someone had the courage to call out – whistleblowing – what they saw.
3) Why do they do it? Plenty of potentially long complex answers, but I find Michael Jones’ book – see the picture above – fascinating. For the psychology behind such events I have also found Cressey’s Fraud Triangle to be instructive. For an enlightening, and slightly frightening read, the article from Fraud Magazine (link below) 2014 is interesting.
The next scandal of this type may not take another 20 years. What if it is right under your nose – now?
https://www.fraud-magazine.com/article.aspx?id=4294983342
Buzzwords of the Week – Cost of Capital
Definition – the required return necessary to make a capital expenditure project, such as building a new factory, worthwhile. This typically involves the weighted average of a firm’s cost of debt and cost of equity blended together.
The cost of capital metric is used by companies internally to judge whether a capital project is worth the expenditure, and by investors to determine whether an investment is worth the risk compared to the return. The cost of capital depends on the mode of financing used. It refers to the cost of equity if the business is financed solely through equity, or to the cost of debt if it is financed solely through debt.
Many companies use a combination of debt and equity and, the overall cost of capital is derived from the weighted average cost of all capital sources, widely known as the weighted average cost of capital (WACC).
Alternate View – I like these quotes: “Charlie (Munger) and I have not the faintest idea what our cost of capital is and we think the whole concept is fairly crazy, frankly.” “I have never seen a cost of capital that made sense to me”
Warren Buffett – CEO Berkshire Hathaway
“Maybe Buffett and Munger are really saying something like this: ‘We always beat investors cost of capital anyway, so why bother measuring it?’”
Professor Stewart Myers, MIT (Myers wrote my MBA textbook on this topic!)
Online Learning – my first online programme – How to Read Financial Statements – is now available. This is a series of 7 online lessons:
1. How finance fits with Strategy
2. The Language of finance
3. Owning & Owing – using the Balance Sheet
4. Measuring & Managing Profit
5. Measuring & Managing Liquidity
6. Budgets, what, why & how
7. The most important part of all
Each lasts between 20 & 40 minutes and includes the slides and videos to help you understand what good looks like in financial terms. The introductory price is $195 and is available now at https://app.mastermind.com/masterminds/8443