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  • The World without Bankruptcy Laws

    Bankruptcy is one of the natural states which a company may find itself in. Entrepreneurship is primarily about taking risks. When companies take risks, some of them succeed, whereas others fail. Hence failure is a natural part of the business. However, many critics of bankruptcy laws believe that there isn’t a need for an elaborate law to deal with the phenomenon of bankruptcy. Just like other contracts between the company and its creditors are left between the two parties, the bankruptcy situation can also be dealt with in the same way. According to these critics, the legal system only adds complication and expense and provides very little in return.

    In this article, we will argue that this is not the case. The bankruptcy law is neither redundant nor wasteful. Instead, it is the existence of the bankruptcy law, which allows companies to function during a financial crisis.

    What Would Happen if there was no Bankruptcy Law?

    • In the absence of bankruptcy law, a large number of firms would face premature liquidation. This is because every creditor would be extremely wary about the financial health of the debtor company. They would be continuously monitoring the financial health, and at the slightest sign of trouble, they would start pulling out their finances.

    • Lack of information would create a panic. Each creditor would want to cash in their money before the others get wind of the situation and try to recover their claims as well. As a result, secured creditors would want the firm to sell their collateral as soon as possible so that their money could be recovered quickly. On the other hand, trade creditors would stop lending more money. This would mean that the roll-over of short term loans would stop, and suddenly the working capital requirement would increase. This would mean that the working capital requirement would increase. This could cause further duress to a company already under financial strain.

    • The rush to recover their own money would create a bank run type of situation. The mistrust between the different creditors would force the early liquidation of the company. Also, since the company will be liquidated immediately, the compensation received will be less.

    • Bankruptcy laws prevent this situation from happening. Because of the bankruptcy law, creditors now know that all creditors with the same seniority will receive the same amount of money. Hence, there is no rush to liquidate the assets before the others. Also, when a company is facing bankruptcy, the court freezes the situation as it is. It first allows the business to improve its financials by continuing as a going concern. Only after the firm fails to continue as a going concern does the option of liquidation come into play.

    • In the absence of bankruptcy laws, many perfectly good firms facing temporary financial duress would be shut down.

    Example: The Great Recession of 2008 is the perfect example to showcase the efficiency of the bankruptcy laws. Five big banks in the United States were about to go bankrupt. However, since their bankruptcy would cause a systemic crisis, the government lent money to them. At that time, it was highly criticized. It was considered to be subsidizing private excess with taxpayers’ money. However, this money kept the banks in going concern. Today, all the banks continue to survive, and the taxpayers who lent money have also been able to make a decent profit.

    • In the absence of bankruptcy law, debt could only be renegotiated when a consensus is achieved. This means that even a small creditor would have excessively large bargaining power. This is because they could hold up the interests of everybody else. The absence of bankruptcy law would create a situation in which blackmailing and horse-trading would be rampant. Bankruptcy law provides some negotiation back to the debtor. Under the bankruptcy law, a unanimous vote is not required. A simple majority will do! Also, if creditors act unreasonably despite fair offers being given by the debtor, then their interests can be crammed down as well.

    • Bankruptcy law mandates continual monitoring of the business of the firm. It also puts the responsibility on those running the firm, that liquidation, if required, should happen at an optimal time when the firm is likely to receive maximum value. Bankruptcy law defines the exact trigger point when the firm must be sent into liquidation. As mentioned above, it prevents premature liquidation. However, it also prevents late liquidation, which could lead to massive financial losses to the people involved.

    • Lastly, if the bankruptcy law was not present, the legal and financial resources wouldn’t be saved. This is because each creditor would have the responsibility of finding what could go wrong and including those situations in the contract. This would mean that expensive legal resources would have to be hired to draw up an air-tight contract, which would later be used to recover money in the event of a default.

    Hence, bankruptcy laws definitely add value. The business world would not be a better or more efficient place without them.

  • The Wirecard and Infosys Scandals are a Lesson on How NOT to Treat Whistleblowers

    What is the Wirecard Scandal all about and Why it is a Wakeup Call for Whistleblowers

    Anyone who has been following financial and business news over the last couple of years would have heard about Wirecard, the embattled German payments firm that had to file for bankruptcy after serious and humungous frauds were uncovered leading to many arrests and the subsequent insolvency of the firm.

    Indeed, the Wirecard scandal shook the German financial, business, and political establishment to the core so much so that it is being likened to the Enron debacle, which happened in the United States in the beginning of the 2000s.

    The Wirecard scandal is a classic case of hubris and connivance at the highest levels of the firm in dubious business dealings and that too, with the full knowledge of the higher ups.

    In this context, it is worth noting that the Wirecard scandal is also a lesson for both regulators and the Whistleblowers who often take great personal risks to expose and report the frauds in their workplaces.

    Moreover, the way in which Wirecard treated its whistleblowers by first denying the allegations, then attacking the integrity of the latter, and worse, intimidating them is something that is unacceptable.

    How the Whistleblower at Wirecard and the Financial Times Uncovered the Fraud

    Whistleblowers are individuals who are courageous enough to report frauds at their workplaces and hence, must be treated with respect and due care.

    It is simply not done for corporates to shout them down or otherwise ignore them and their complaints and in the process, undermine their courage and confidence.

    This is what exactly happened in the case of the Wirecard, which ultimately forced the whistleblower to go to the premium business publication, Financial Times or FT, with his findings on the fraud being perpetrated at Wirecard. FT, took it upon itself to assign reporters and experts on the case and it was only after sustained investigation by them that the German regulators took cognizance of the fraud at Wirecard leading to its demise.

    While Wirecard’s treatment of the whistleblower was reprehensible enough, it also exceeded all boundaries of restraint by attacking the Financial Times and its staff who were engaged in the case.

    It is a matter of pride for the whistleblower and the publication that Wirecard ultimately was found guilty of serious malpractices and heads began to roll among its senior executives, as well as it being declared insolvent. However, it is a fact that whistleblowers take risks.

    Why Whistleblowers are Critical to Society and How We Need to Protect Them

    If one browses through textbooks on business and management, whistleblowers and their role in the modern corporate world is often treated as an afterthought and given a few pages of discussion in such texts.

    However, it is our argument that it is high time for the corporate world and the regulators as well as the broader public to demand changes in the way whistleblowers are treated.

    For instance, it is clear from the many corporate scandals over the last few decades that serious frauds often are invisible to the external world and many leading Blue Chip firms often present a rosy picture of their business, whereas in reality, they would be in Neck Deep trouble owing to malpractices.

    This is where insiders and their knowledge and suspicions of frauds are valuable as they have access to information that is often hidden purposefully from the outside world.

    Therefore, whistleblowers play an important and critical role in the contemporary corporate ecosystem and so, firms and regulators have to have codes of conduct on dealing with such individuals.

    It also goes without saying that whistleblowers need to be offered legal and other forms of assistance, support and protection to ensure their personal safety.

    The Way in which Infosys Handled Whistleblower Complaints Leaves a Lot to be Desired

    In times when many corporates have been found to be deficient in aspects of corporate governance and in some of these cases, the boards themselves have acted improperly; it is more the reason for regulators and legislators to draft legislation to address how corporates must deal with whistleblowers.

    For instance, in the case of the Indian Software giant, Infosys, the whistleblowers were first dismissed and then laughed at, and it was only after they went to the press as well as to the stock exchanges in addition to anonymous placement of the facts on select websites that Infosys and the regulators began to act.

    This is again an example on how NOT to handle whistleblower complaints. Moreover, it is a sad fact that unlike in Wirecard’s case, there was no significant damage to Infosys or its senior leadership from the episode.

    It speaks volumes about the India Inc. that whistleblowers are regarded as irritants and nuisance, instead of as courageous individuals who risk everything to report frauds.

    More so when so many of the whistleblowers often feel torn between their sense of loyalty to their employers and the moral desire to uncover and complain about frauds and malpractices in workplaces.

    Going Against the Status Quo

    Last, what the Wirecard and Infosys cases reveal is a deep distrust of anyone who dares to go against the status quo in corporates and this is something that business leaders and other visionaries should address.

    More so when such allegations are made against the very top leadership as such leaders are expected to lead by example.

    In addition, whistleblowers often prevent the entire firms being dissolved as regulators who act in time often salvage the situation and avert collapse of the firms.

    To conclude, we need a new approach on dealing with whistleblowers by corporates and the regulators.

  • Why the Digital Age Demands Decision Makers to be Like Elite Marines and Zen Monks

    How Modern Decision Makers Have to Confront Present Shock and Information Overload

    We live in times when Information Overload is getting the better of cognitive abilities to absorb and process the needed data and information to make informed decisions.

    In addition, the Digital Age has also engendered the Present Shock of Virality and Instant Gratification wherein decision makers do not have the luxury of taking decision after careful consideration and Due Diligence.

    Indeed, when a Million Tweets and Facebook posts demand your urgent attention and require your instant responses, how can decision makers take the right, or for that matter, at least, notionally accurate decisions that address both the short term and the longer term consequences of such decisions.

    In short, being online all the time, and being subject to an endless barrage of digital knocks means that decision makers are often frazzled and left wanting.

    This is the reason why many Political and Business Leaders often complain that the Convergence of Social Media and Our 24/7 World is leading us to an abyss of Present Shock where everything happens at once and when decisions have to be taken in split seconds, which was earlier the domain of Combat Units.

    Why Decision Makers in the Present Times Should Think Like Elite Marines in Warzones

    Indeed, this is the reason why many leading American corporates are seeking the help of Navy SEALS and Defence Marines to help their Managers and Senior Executives navigate the tricky terrain that is modern decision making.

    Moreover, just as Elite Special Forces have to watch out for Minefields and Booby Traps when they patrol enemy territories, contemporary decision makers too have to be on the lookout for potential minefields of Disinformation and Fake News that can derail and worse, destroy the credibility of decision makers and their firms.

    In addition, the Reflexes and the Response Times have to be coordinated in split seconds, which is another reason for our argument that decision makers in these times have to think and act in a manner similar to Elite Combat Units in Warzones.

    Apart from this, another Dilemma that decision makers have to confront is the consequences of their decisions in quick response times since the time lag between decisions and consequences is now measured in minutes and hours, rather than days and months.

    This calls for a surprisingly high degree of Agility and Quick Thinking that soldiers are better at rather than staid Business Leaders in Pressed Suits.

    What is the OODA Loop and How Decision Makers Can Use it to Make Agile Decisions

    Turning to the theory behind our argument, the term OODA Loop comes into focus. The OODA Loop stands for Observation, Orientation, Decision, and Action that characterizes how soldiers make decisions.

    First, they have to observe the situation, orient themselves to the circumstances, decide on the best possible course of action, and then act accordingly.

    All this happens in a matter of minutes, or even seconds, since the enemies do not wait for the soldiers to ponder over their responses.

    Similarly, modern decision makers have to first observe how events are unfolding, orient themselves to the circumstances of the moment, decide on the appropriate action in a rapid manner, and almost immediately, implement the decision.

    Moreover, the OODA Loop also includes acting on the feedback that is also instantaneous and which can have grave consequences, if ignored.

    The OODA Loop is extensively used in the WestPoint Academy where generations of United States Marines have been trained and whose graduates often are among the Best and Brightest of the Defence Personnel.

    Therefore, this theory can be used by modern decision makers as they confront vital decisions that have to be made in a matter of minutes in our tech driven 24/7 world.

    Being Zen like Helps Decision Makers to Avoid Cognitive Dissonance, Biases and Traps

    Having said that, there are other aspects why decision making in the present times also needs a certain Zen kind of focus.

    Indeed, this is the reason why many Spiritual Gurus are being asked to assist Business Leaders in developing the necessary Fortitude and Inner Strength to deal with the complexities of modern decision making.

    For instance, quick decision making cannot be taken in a Troubled Frame of Mind. At the same time, decision makers have to avoid the Cognitive Dissonance Trap wherein there is a disconnect between their thoughts and actions.

    Apart from this, Cognitive Biases and Emotional Triggers have to be set aside as well.

    All this requires advanced levels of concentration and sagacity that only a Focused and Self Aware as well as a Calm and Composed person can.

    As one reads the business press, the confluence of Western Armed Forces concepts and the Eastern attributes of Patience and Mental Strength of the Zen Monks are being used by Business Leaders worldwide.

    In our working experience, we have been to many Leadership Retreats where we found the trainers to use these concepts to train us in the art and science of decision making in the Digital Age.

    Preparing the Leaders of Tomorrow

    Last, it is also the case that Business Schools incorporate these insights and theories from the West and the East in their curriculum so as to prepare the next generation of decision makers for the VUCA world or the world that is Volatile, Uncertain, Complex, and Ambiguous.

    Already some Business Schools in India have experimented and then successfully incorporated these approaches to decision making.

    To conclude, as the world becomes more fluid in the Post Pandemic Age, it is necessary for decision makers to be as sagacious as Zen Monks and as Agile as Elite Marines at the same time.

  • Why Indian Firms Must Strive for Strategic Autonomy in Their Geoeconomic Strategies

    Geopolitics, Economics, and Geoeconomics

    In the evolving global trading and economic system, firms and corporates are impacted as much by the economic policies of nations as they are by the geopolitical and foreign policies.

    In other words, any global firm wishing to do business in the international sphere has to be cognizant of both the economic policies of the target countries and the origin countries as they must be towards the geopolitical strategies.

    This is especially the case in the post 911 world where geopolitics and economics combine to form what is known as Geoeconomics or the practice of diplomacy and foreign affairs keeping in mind the economic forces at work.

    For instance, Iran has been the subject of sanctions from the United States in recent months and the US has barred firms from transacting business with it.

    However, this has not deterred the Indian Firms, particularly the Indian Oil Companies wherein they have chosen to exert their independence and neutrality to circumvent the sanctions and continue operating there.

    Thus, it is the contention in this article that Indian firms must aim for strategic autonomy and position themselves in such a manner where they are equidistant from the strategies of other international powers and consequently, pursue business strategies that are governed by a strong streak of autonomy.

    Why Indian Firms Must Pursue Strategic Autonomy

    Continuing the discussion, it is worthwhile to note that Strategic Autonomy as far as Geoeconomics is concerned cannot be conducted in a Vacuum or be independent of the governmental actions and policies.

    Indeed, considering the fact that Geoeconomics means that geopolitics too needs to be taken into account, it is the case that Indian firms must choose to act in concert with the Indian government.

    This can be seen in the way the Indian Defense Ministry and Foreign Affairs Ministry have chosen to do business with Russia irrespective of some sanctions on it by the US.

    Indeed, given the close linkages between Russia and India, especially where arms purchases are concerned, it goes without saying that the Indian government is encouraging the Indian firms to be independent in their approach and put the interests of the country and theirs as well before considerations about what and how their business interests elsewhere are impacted.

    In other words, the Indian government is actually telling Indian firms to balance their commitments with the US and other great powers so that they do not lose out in the bargain.

    Need to Balance Economic Interests Worldwide

    This is illustrated by the examples of some Indian Firms have chosen to desist transacting business with Russia and Iran due to the risk of jeopardizing their business interests with the US.

    Indeed, given the fact that Indian Firms do have significant operations around the world, they do need to take a call on prioritizing which comes first when they transact commercially.

    Moreover, the latest round of trade wars is another example why India and Indian Firms ought to pursue Strategic Autonomy.

    With the US and China engaged in a “no holds barred” contest of levying tariffs and penalties against each other, India should avoid getting caught in the crossfire. On the other hand, it cannot sit idly by while its exports dwindle and its imports increase.

    This is the reason the Indian Government in recent days has levied tariffs on some goods imported from the US without engaging in Rhetoric and striking a balance between the interests of staying aligned to the US and China at the same time.

    What all this means is that Indian firms must take the lead here and follow the example of many emerging and even developed nations where their firms often ensure that they remain committed to their business and national interests.

    Non Alignment, Closeness to the US, and the Way Ahead

    In times when the global economic system is characterized as being fragmented and where both the US and China are engaged in a power contest with Russia and the EU in between, it makes sense for emerging market economies such as India to play their cards well.

    While in earlier decades, the principles of Non Alignment meant that India pursued this strategy, though in reality it was close to Russia, in recent decades, it has drawn closer to the US mainly due to the Geoeconomic imperatives.

    On the other hand, it has also maintained good relations with the other powers and given the interlinked and interconnected global economy, it must continue to pursue a foreign policy shaped as much by high sounding principles as it must according to the economic objectives.

    With nations around the world choosing to put more emphasis on Geoeconomics, it is high time Indian Corporates nudged the Indian government to include their concerns in its foreign policy objectives and pursue policies accordingly.

    This is already happening to some extent as can be seen from the way in which business delegations often accompany officials on visits abroad.

    Conclusion

    Lastly, Strategic Autonomy is also important mainly due to the fact that Indian being a culturally diverse country has to keep in mind domestic interests in its global policies.

    The same goes for Indian firms that often are dispersed across the country and hence, they too have to keep diversity and the need for inclusivity in mind when they transact business abroad.

    In other words, domestic compulsions play a part as well and hence, taken together, the points discussed so far indicate how India and its businesses would be well served to actualize strategies that take into account all these factors.

  • Why Government Should Not Invest Public Money in Sports Stadiums Used by Professional Franchises

    In the previous article, we have already come across some of the reasons why the government should not encourage funding of stadiums that are to be used by private franchises.

    We have already seen that the entire mechanism of government funding ends up being a regressive tax on the citizens of a particular city who end up subsidizing a particular team.

    There are many people who do not clearly understand the economic rationale behind not building stadiums. However, they are well aware of the fact that a lot of professional sports franchises are owned by billionaires and if there was any possibility of obtaining a profit by running these facilities, then the franchise owners have enough resources to do so themselves.

    The fact that some of these billionaires are insisting that public resources should be used to build the stadium can be considered evidence that the stadium is not a viable financial project.

    However, in order to make the economic logic clearer, we need to spell out the exact logical fallacies in the muddled reasoning and obfuscation provided to the general public. The common arguments given in favor of government funding of such projects have been debunked below.

    1. Athletes Spend Money Outside: The distribution of economic benefits in a sporting franchise is set up in such a way that the vast majority of the money is paid to superstar players as well as the top management.

      The bottom-level workers who work in the offices as well as at the stadiums are not paid much. Hence, the end result is that most of the money which is accumulated from fans of the team who are present in the city is sent to the bank accounts of these top personnel.

      It is likely that most of the players as well as the management do not stay in the cities in which they play. It is also possible that they do not spend most of the money they receive as remuneration in the local economy. Hence, if a government builds a stadium, it is actually assisting the team in transferring their economic resources to other cities.

      In the absence of such a stadium, the money would probably have been spent locally and would have helped local businesses. Hence, it can be said that not only does funding a stadium not help in creating economic wealth for the host city, but it can actually lead to the destruction of such economic wealth.

    2. Increased Capital Values: It is important to understand that by building stadiums with public money, the local governments are essentially subsidizing the billionaires. The end result is that these billionaires do not have to spend a large amount of money in order to keep running their franchises.

      The additional money that they have not spent keeps on piling up on the balance sheet of these sporting franchises. This increases the notional value of these franchises which many billionaire owners are able to realize once they put the franchise up for sale.

    3. Increase in Tourism: Another argument given in favor of government funding of sporting stadiums is that it helps in increasing tourism in the local economy. The logic is that sporting events attract tourists from other cities and help create additional economic activity for the local economy. This may be true for some important games such as the final of a tournament or a match between two popular teams. However, when it comes to the vast majority of the matches, they are watched by the local population itself.

      Tourists who watch such matches generally do not visit the city primarily for sports events. Instead, most of the tourists are already in town for business purposes or to visit their family and end up visiting the stadium. Hence, it would not be appropriate to say that any additional revenue is generated on account of the presence of the stadium.

    4. Alternative Projects: Governments generally have a limited amount of funds at their disposal. Also, they tend to have a lot more projects that they can invest in as compared to the funds that they have. As a result, the decision regarding whether or not a stadium should be funded cannot be taken in isolation.

      It has to be taken in relation to the other projects. As a result, there is almost no rationale for investing public money in stadiums. Public money needs to be invested either to obtain maximum returns or for social service.

      If the money is being used to build stadiums, then the end result is that sub-optimal returns are being generated. Also, the government is not doing any public service by undertaking these projects. Instead, they are helping the rich become richer.

    5. Branding/Image Benefits: Since there is no direct financial benefit that can be attributed to public funding of stadiums, proponents of such investments often try to obfuscate and mislead the public by stating intangible benefits such as branding and image building. However, there is a significant outlay involved in the funding of such projects.

      On the other hand, branding and image benefits are intangible and hence cannot be used to quantify the outcomes. The proponents of government funding in sporting facilities end up using this vagueness to their advantage.

    The bottom line is that if billionaire owners as well as star players have to hold the local municipality at ransom and threaten to relocate to another city, then the project certainly isn’t a good investment.

  • The Age of Oversupply: Why the Future Would be Demanding on the Present Generation

    The Paradox of Too many People, Capital and Too Few Jobs and Resources

    The present times are characterized by an oversupply of everything related to the job market and the presence of so much capital at the disposal of companies. On the other hand, the physical resources needed like oil, gas, minerals, and water are in short supply. This means that a paradox is created where there are more people than resources and more capital than avenues for productive investment. This “double whammy” would hit the current generation hard, as they have to contend with the paradox of too much labor and at the same time too few physical resources.

    A situation where there is stagnation in the job market and inflation in the price increase is known as stagflation. While the hitherto protected and insulated economies of the west are now undergoing a painful transition to high unemployment and low growth, the Eastern world is realizing that the good times are over and hence, the return to the dizzyingly high rates of growth and plentiful employment is impossible. This is leading to a situation where the present generation is becoming frustrated and showing their anger through mass protests and strikes on just about everything that bothers them.

    The Perils of Oversupply

    Oversupply of labor means that when employers advertise for jobs, there is more than hundred times the number of applicants for every vacancy. This means that job seekers have to contend with low paying jobs far lesser in pay and working style than what they had studied. Indeed, some media reports have shown that engineering graduates in India are working in grocery stores and in menial jobs that do not have any connection whatsoever with their education.

    Many youth in the west as well as the east are delaying marriage, having kids in case they are married, and are generally not leaving home and staying their parents as they can save on living expenses this way. This situation is a recipe for disaster as can be seen from the events of the Arab Spring and the Occupy movement where disgruntled and disaffected youth took to protests and social disorder as a means of expressing their anger.

    Further, with so few jobs and so much capital at their disposal, companies are putting off hiring and instead, deploying their liquidity in the stock market and other forms of speculation that do not result in net job creation and only serve to exist as a highly lucrative source of income.

    Speculation instead of Job Creation

    This is the reason we see the stock markets rise even though the economy is in doldrums. This is also the reason we see the capital drifting towards speculation instead of productive employment. Further, investment needs resources that are dwindling and hence, corporates have realized it is better to speculate rather than invest in scarce resources. Even those companies that need resources are either putting off their expansion plans or lessening their output from the existing resource base.

    Therefore, the paradox of oversupply of capital and labor and at the same time the dwindling resources means that there is no net value adding economic activity wherein the only growth is from the services sector that does not need any of these factors of production. This can be seen from the way in which the jobs that are being created are from the services sector where the fresh graduates are flocking to for employment.

    Of course, as mentioned earlier, services can mean anything from high-end finance and IT to low end hair salons and retail stores and hence, it is important to note that fresh graduates be realistic about their chances. Instead of building castles in the air, they must have their feet firmly on the ground and hence, must apply for employment accordingly.

  • Why Do Mutual Funds Lend To Promoters?

    After the banking crisis, the Indian capital markets are facing another dire situation. It has recently come to light that many mutual funds have been lending money to promoters of companies.

    It needs to be understood that these loans are not being made to companies but rather to promoters of companies. The problem is that some of these loans may have turned bad. This is causing panic amongst mutual fund investors, many of whom had no idea that they had exposure to companies such as IL&FS and DHFL! In this article, we will have a closer look at the loans being sanctioned by fund houses as well their economic impact.

    How Mutual Funds Lend to Promoters?

    Many times promoters are in need of cash. Perhaps they want to expand their business or have to meet working capital requirements. However, after the NPA crisis, not many public sector banks are willing to lend money to corporations until they have a rock solid credit rating and also provide adequate collateral. Many banks do not accept equity shares as collateral.

    This is where debt based mutual funds come in. These mutual funds do not have to adhere to regulations like banks have to. Hence, they are free to lend money to corporations or individuals if they are reasonably confident that they will be paid back.

    Mutual funds often fund promoters by forming separate structures. They provide loans only against the shares of blue chip companies. Also, since shares are believed to be extremely volatile, they only finance up to 50% of the market value of the shares. At least in theory, this gives the lenders enough margin to cut their losses in the event of a downturn. It is also known that the securities work like margin loans. For instance, if the value of the collateral drops, then mutual funds have the right to insist on more shares or liquid securities. The idea is to avoid as much risk as possible.

    Why Do Mutual Funds Lend To Promoters?

    The real reason why mutual funds lend to promoters is that they want to earn a higher return on their investment. Debt funds are under constant pressure to outperform their peers. Outperforming is not easy if the fund’s portfolio only consists of publicly traded securities. Promoters do not have a very high credit rating. Also, their collateral also fluctuates in value. This is the reason why they are willing to pay higher interest rates. In the past few years, this higher rate has been the reason that some funds have outperformed the others.

    The Problem with Such Loans

    There is nothing inherently illegal or immoral about these promoter loans. However, it needs to be understood that these loans are actually quite risky. Hence, it is the responsibility of mutual funds to explain the risks to their investors. Some of the risks related to mutual funds have been listed down as follows.

    • Default Risk: Just like with any loan, there is obviously a risk of default with loans to promoters as well. However, it needs to be understood that markets react very badly when they find out that the promoters have pledged their shares. As a result, it is likely that the prices of the shares may drop very rapidly. This could happen because of two reasons.

      Firstly, it signals to the markets that the promoter who happens to be an insider to the business is trying to exit it! Also, promoters own huge blocks of shares.

      When these huge blocks are put on the market for sale, they tend to increase the supply without any corresponding increase in the demand. As a result, the price plummets rapidly. These scenarios may seem far-fetched but a few Indian mutual funds have found themselves stuck with promoter debt. They are being forced to enter into agreements with promoters since they cannot really afford to sell the debt without risking losing a significant part of their investment.

    • Liquidity Risk: There is another major problem with promoter loans. These loans are bilateral agreements between two parties. There isn’t really an active market where such contracts are traded. Hence, in short, there is no secondary market for such agreements. As a result, when a fund house lends money to a promoter, it has no option but to obtain that money back from the promoter itself. The funds house will be forced to hold the loan till maturity. They cannot really sell their loan to third parties without taking a substantial haircut.
    • Problem With Due Diligence: Lastly, fund houses do not have the infrastructure required to conduct due diligence for loans that they give out. For instance, a promoter may want to pledge his shares in one company, raise money and then invest in another business. The problem is that the fund house has no idea about the viability of the other business. Most of the times, they are trusting the judgement of the people that they are lending to. Obviously from a lending point of view, this cannot be considered to be a good practice.

    The bottom line is that mutual funds lending money to promoters is nothing new. However, given the current environment, there is unnecessary scaremongering over such loans. Mutual funds only need to make their investors aware that such loans may be riskier than others which is why they provide better returns too!

  • Why College Education Should Not Be Free?

    President Ronald Raegan had once famously said that “Big government is not the solution to the problem. In fact, big government is the problem?” This line is remarkably applicable to the current situation surrounding the student debt crisis. The student debt crisis in the United States has reached epic proportions. The total loans outstanding are worth trillions of dollars. More than 10% of these loans are in default even though the interest rates are at historical lows. If the interest rates are raised, many more of these loans will turn bad. Hence, it would be fair to say that student loans pose a systemic debt crisis in the United States.

    Education has been the backbone of the American economy for many years. The reality is that it shouldn’t be so expensive in the first place. The costs of education have shot up ever since the government started interfering with the financing of student loans. Unlike any other loan, students do not have to show means of repayment when they are given a loan. Therefore, there is practically no way to ensure that the loan will be paid back in the future.

    Government policies have made it mandatory to give out loans to pretty much every student that asks for it. This is the reason that many young adults, who have no idea about the kind of financial burden that they are taking on sign away their lives every year. Many young and old adults are struggling with piling student loans now. This is the reason that these loans have become a political agenda.

    Once again, instead of solving the problem at its root cause, the government is suggesting ways and means of making college education free. Such a move would not solve the problem but instead, exacerbate it. In this article, we will have a closer look at the policy options which are being flouted to make college education free to understand why these policies are flawed:

    Waiver of Tuition Fees and Debt Forgiveness

    The most popular policy being proposed is the complete waiver of tuition fees in America. Given the fact that University education is already expensive, this would cost the American taxpayer a lot of money.

    Democratic senators have also proposed that $50,000 be waived off from every outstanding college loan in the United States. This extremely generous policy is likely to cost the American taxpayer $1.6 trillion per year! The problem with this policy is that firstly, it will send the American debt through the roof.

    Secondly, this policy will not solve the root cause. An abundance of money has made university education expensive. Instead of rationing the money that is given out to the universities, the government is proposing an unlimited supply of money to the same universities.

    If this policy is followed, the costs of university education will balloon over the next few years bankrupting hard-working taxpayers in the process.

    Taxes on Wall Street

    The government loves to play Robin Hood since that helps with building a positive image which has obvious political benefits. There are many senators who say that the proposal of giving away free education will be revenue-neutral. They say that the money for these loans will be provided by a tax which is imposed on the speculative activity on Wall Street.

    Such policies play to the popular perception that people on Wall Street have an excess of money, and hence money should be taken away from them. The reality is that each and every taxpayer, even the poor ones, invest money on Wall Street.

    The money in the 401(k)’s and retirement accounts is plowed back into Wall Street. Hence, if a tax is imposed on Wall Street transactions, it is still being paid by a lot of poor and middle-class personnel.

    Also, Wall Street does not keep all the money to itself. Instead, Wall Street is only a mechanism to transfer money from the savers to the investors. Therefore, if a tax is imposed on this process, the number of investments will be curtailed. A fewer number of companies will get funded, and the job creation process will be impacted. Once again, this will further exacerbate the problem instead of solving it.

    Reversal of Tax Cuts

    Another proposal being suggested by democrats is that the tax cuts being provided after the 2017 act by Donald Trump be reversed. Once again, this would be a problem for the middle class. The middle class was the recipients of tax breaks as well as pay hikes because of the tax breaks being received by the companies.

    If these tax cuts are rolled back, many middle-class families will bear the brunt. The problem with this policy is that it forces all people to make an involuntary contribution to benefit only a handful of people. Many of these taxpayers have not been able to attend college themselves. However, the government is forcing them to pay so that other people can attend college. This is obviously hypocritical and ironical.

    The reality is that college education is not meant to be free. Instead, it is supposed to be reasonably priced so that middle-class people can afford it. Also, colleges should have endowments wherein merit-based students can also have access to the same educational institutions.

    The goal of reasonably priced education can be met with minimum government intervention. The idea of throwing money at the education problem to make it go away has obviously failed and hence must be discarded.

  • It’s Now or Never: Why Business Must Embrace Sustainability before it is Too Late

    How Climate Change and Ecological Damage is Hurting Our Planet

    Everywhere we look around us, we see the impacts of our unsustainable lifestyles. Whether it is the Australian Bushfires, the Amazon forest burning, or the unseasonal storms and hurricanes, the effects of climate change and eco unfriendly business and lifestyle practices are taking a toll on our planet.

    Indeed, even the recent outbreak of the Coronavirus shows how fragile are our defences are against the effects of unsustainable business and consumerist models.

    No wonder that in the West, there is a movement known as the Extinction Rebellion which calls for urgent action on climate change and ecological issues to ensure those future generations have a liveable world.

    Of course, there are many who say that it is probably Too Late and hence, it is better to enjoy whatever we have and whatever we are doing.

    This seems to be thinking of President Trump who has rolled back much of the environmental safeguards that his predecessor, Barack Obama, put in place to address sustainability issues.

    Indeed, this is also the thinking that permeates most world leaders who scoff at the mention of sustainability and climate change.

    Anti Science Mindsets, Denialism, and Bridging the Gap between the Two Camps

    So, does this mean that we have to resign ourselves to our fates and let the Planet Burn? Moreover, are the average citizenry so helpless when the leaders are behaving irresponsibly that they cannot do much about anything?

    And, what is the role of business in this whole debate wherein it continues on its ecologically damaging path with its Business as Usual strategies?

    The answer to these questions lays more in terms of mindset and way of thinking, rather than anything.

    For instance, climate change activists routinely run into fanatics who deny climate change and who insist that the climate always changes and there is nothing human made about it.

    In addition, with the ascent of populists and nationalists worldwide, it has become the norm to attack scientists and science and the anti rationalists ensure that they drown out any voices of sanity with their High Decibel chants.

    Therefore, what this shows is that there is a Wall of Denial between the two sides and hence, it is incumbent upon businesses and business leaders to take the lead and Bridge the Gap.

    The need for businesses to take steps is high as they are the only ones who can spur some action by talking to both sides and bringing them together.

    Business as Usual Would Not Do as We Have Reached the Point of No Return

    Business has to also lobby the Powers That Be in all countries and urge them to take action on climate change and eco friendly practices. While this might seem idealistic at first glance, it is very much a practical and sane and rational approach.

    This is because it is in the interest of business to act on climate change as its bottom lines can be impacted due to a warming planet and a burning Earth.

    Indeed, the stakes could not have been higher as some experts predict that we have reached the Tipping Point and are now at the Point of No Return as far as climate change and ecological damage are concerned.

    Therefore, it is either mass survival or mass extinction and hence, from a purely materialistic and profit oriented perspective, it is in the interest of business to take the lead on these issues.

    As mentioned earlier, there needs to be a mindset change and the old paradigm of Milton Friedman, who proclaimed that The Responsibility of Business is Business, must be discarded in favour of new thinking. This is the only thing that can save from extinction.

    Global Business Must Walk the Talk and Act Before it is too late

    Having said that, it is also a fact that global businesses have been notoriously lethargic and tardy as far as their responsibility and commitment to fight climate change and ecological damage are concerned.

    Indeed, if one were to go by the words and actions of many business leaders in the recent past, we find that more often than not, they are urging governments to rollback rule and regulations that are environmentally friendly.

    In other words, they are the ones who are responsible for the damage and they are the ones who are blocking meaningful action on these issues.

    At the same time, there is also an element of Hypocrisy here as they talk Big but Act in the Opposite Direction.

    So, the need of the hour is for business to Walk the Talk and do something about climate change and ecological destruction. Green Washing or the Spin around Corporate Social Responsibility must be avoided and there must a genuine attempt to embrace sustainability before it is Too Late.

    In addition, they must realise that responsibility is good for business as well as the recent research on this topic proves that sustainable business practices pay off over the longer term.

    Conclusion

    Last, the 21st Century can be thought to be the Transition Century wherein we either move towards a sustainable future or are hurled back into the Dark Ages.

    The Millennial generation are those who have the most at stake as it is their future that is up for grabs.

    Therefore, it is the case that they take the lead and some action is visible in the form of the Green New Deal in the United States as well as by the Democrats running for election who have promised action on climate change and ecological issues. To conclude, it’s now or never.

  • Why are Corporations Hoarding Trillions in Cash?

    Corporate America is flush with cash! Collectively, the Amazons’, Apples’ and other such publicly traded mega corporations account for close to $2 trillion in cash. This excessive hoarding of cash in unparalleled in financial history and hence has left a lot of economists flummoxed.

    In this article, we will try to understand why American corporations are holding on to piles of cash instead of investing it.

    The Problem with Piles of Cash

    Financial and non-financial firms hold cash for very different reasons. It is not unusual for financial firms to hold on to a lot of cash. Hence, in order to be fair, it is important that only the cash holdings on non-financial firms are being considered in this article. However, that does not seem to make too much of a difference since non-financial firms account for $1.6 trillion of this cash pile.

    Huge cash piles have traditionally been considered to be a problem for the company holding them. This is because if a company is holding a lot of cash, it means that the company is holding less of other assets. The problem with cash is that in the short run, the yield is abysmal. If cash is held in a savings account or a money market account, the yield is negligible. In some cases, the yield may even be negative. Therefore, normally, companies do not hold much cash since it depresses their own return on equity.

    However, hoarding cash is bad for the overall economy as well. The stockpiles of cash being held by Amazon or Apple could be used by small businesses to meet their liquidity needs. By holding on to huge sums of cash, these corporate giants are preventing the circulation of cash and reducing the velocity of money. When the velocity of money reduces, the result is seen in slower GDP growth. Hence, it would be fair to say that American multinational corporations are withholding the growth of thousands of small businesses worldwide.

    Why are American Companies Holding this Cash?

    According to economic theory, there are only two reasons to hold on to cash:

    1. First is the transaction motive. If companies are afraid that they may not be able to raise funds when needed, they tend to hoard cash. This allows them to be less dependent on banks and other financial institutions. The fact that recession may just be around the corner gets a lot of companies worried about their finances. Excess cash allows the firms to be self-sufficient and avoid the resultant stress. However, only a small amount of cash is required for this purpose. There is no need to hoard $1.6 trillion for purely transactional purposes. Hence, it would be safe to assume that most of the cash being held in corporate vaults is not for self-defense.
    2. The second and most likely reason to hold on to large amounts of cash is tax avoidance. A large chunk of this $1.6 trillion cash is being held by American corporations in offshore accounts. As per the current tax law, American corporations are supposed to pay tax on the income that they generate all over the world. However, this tax only becomes payable when the money is repatriated back to America. American corporations are using this provision as a loophole. They are not transferring the cashback to America. As a result, they are indefinitely deferring the tax payment by keeping the money stashed abroad. If these firms want to invest money in any other country apart from America, they can mobilize the funds directly to the destination and avoid paying taxes in America altogether.

    The Argument for a Tax Holiday

    This big stockpile of American cash has been a lot in the news lately. As a result, it has tempted many American lawmakers to argue that a tax holiday should be provided to these corporations which are already worth billions of dollars. According to these lawmakers, there should be a fixed period of time when companies should be allowed to repatriate their cash without having to pay any taxes. They believe that this will spur more investments in America and lead to more job creation.

    The problem is that American corporations are already known for paying painfully low amounts of tax. Companies like Amazon have a bad reputation since people believe that they earn billions but don’t pay any taxes. Hence, convincing the American taxpayer to provide another tax holiday is going to be a difficult task.

    On top of that, there are several American corporations which have actually done the opposite. Many corporations have taken tax holidays and reduced their workforce instead of increasing it. For instance, pharmaceutical giant Merck was allowed to repatriate close to $6 billion tax-free in 2005. However, within a year, the company fired more than 4000 American workers! Similarly, other companies such as Hewlett Packard have also fired 15000 personnel after getting a tax holiday over an income of $15 billion.

    It is high time that the government stops succumbing to corporate blackmail. American companies are obliged to report their incomes in America. The government should change the tax laws to ensure that a big chunk of this cash is either invested or repatriated back to America.