Financial Management Questions

Questions: 1. Explain what is meant by the term corporate governance. Recently, a scandal involving Volkswagen was revealed. Based on your knowledge of corporate finance, critically assess what has happened to the value of Volkswagen since the emissions scandal was uncovered. Why do you believe the value has changed and what impact this might have on the corporate governance policies of Volkswagen going forward? How can Volkswagen mitigate the risk of events such as this one occurring in the future? 2. If a bond with a face value of 1,000 and a coupon rate of 7% is currently selling for 1,046, what does that tell you about the current yield to maturity of the bond relative to the bonds coupon rate? Explain why this is the case. Answers: (1). Corporate Governance Corporate governance refers to set of rules, regulations and policies through which the company operated and controlled. It makes sure accountability and transparency by the management of the company with an objective to increase the value of company. It includes action plans, internal controls, and corporate disclosure. It also maintains transparency in operations of a company. Volkswagen (VW) emissions scandal The scandal is related to cheating in emissions tests by VW in the United States (US). In September 2015, Environmental Protection Agency (EPA) discovered that diesel cars being sold by VW in US had device or software which is triggered when the cars are tested and it changes the performance of such cars to satisfy the US emission laws and the engines in these cars emitted nitrogen oxide up to 40 times above than the allowed limit. The event that led to exposing the above scandal is the on-road testing in May 2014 conducted by California Air Resources Board by researchers at West Virginia University. The researchers found that some VW cars emitted almost 40 times the allowed nitrogen oxides when tested on road. Impact on value of Volkswagen since the emissions scandal was uncovered Due to the above scandal following impact was observed on VW VW decided to recall millions of cars across countries Resulted first quarterly loss for 15 years of operations by VW in late October 2015. EPA can also fine the company for $37,500 as maximum for each vehicle that breaches the emission norms which can lead to a maximum fine of $18bn approximately. Chief executive as well as the head of its American operations resigned from their posts and VW also suspended several high-ranked executives. VW stock price took a toll and registered quiet sharp fall in its share prices which led to fall in the market value of the company. VW posted close to $6.2bn loss in 2015 mainly due to above scandal and its associated costs. Impact on corporate governance policies of Volkswagen in future Till the scandal, VW board had a non-independent majority which questions its board integrity and differential voting rights. It was due to its internal guideline which required that half of the directors be employee elected. VW also had large family holdings which compounded the effect of non-independent board. The said scandal may lead to the following impact on corporate governance policies of Volkswagen in future VW may adopt the policy of having more number of independent directors from technical fields which will play a pivotal role in companys operational guidelines. Its internal guideline which required that half of the directors be employee elected may be abolished. VW may adopt more transparent communication methods between management and its stakeholders with regard to its policies regarding various norms by the government of the country in which it is operating and its product offering in those countries. It may also lead to more refined policies with regard to risk management in the company and also with regard to its marketing policies. How can Volkswagen mitigate the risk of events such as this one occurring in the future? To avoid the risk of above much event occurring again in future, VK may adopt following policies in its operations Establish stringent internal control systems which flag the issues and its associated risks in advance. Adopt such marketing policies which are not manipulative or misleading to the potential customers. Delink executive pay from revenues/profits only basis and link it to other performance factors. Create ethical culture and environment in the company between its employees and management. (2). Face Value: 1,000 Coupon Rate: 7% Current Price: 1,046 Yield to maturity (YTM) is the return that the bondholders will earn if the bond is held till its maturity and is based on the coupon rate current price of the bond. In other words YTM is that discount rate at which future payments from bond equals to the current price of the bond. Thus, higher YTM as compared to its coupon rate leads to lower current price and vice versa. (Investopedia) In the given question, Current price of the bond is higher as compared to its face value which signifies that YTM for the bond is lower than the Coupon rate offered on the bond which can be understood as the expectation of the market is of lower interest rates on the specific bond while it is offering a higher coupon rate than expected and thus it is commanding a higher price in the market. References Capital Investment, Capital Investment Appraisal / Appraisal Techniques, viewed on 26 May 2016, Drake, P., Capital budgeting techniques, viewed on 26 May 2016, Finance formulas, Yield to Maturity, viewed on 26 May 2016, Gates, G., Ewing, J., Russell, K. and Watkins, D., Explaining Volkswagens Emissions Scandal, The New York Times, viewed on 26 May 2016, Hotten, R., Volkswagen: The scandal explained, BBC News, viewed on 26 May 2016.