Money, Banking, and International FinanceYour return from your Facebook investment is the dividend yield plus the capital gain, or
16.1%. Corporate managers can influence the dividend yield that ranges approximately 2% per
year while they have little influence on the capital gains that could range as high as 12% per
year. Unfortunately, investors could face catastrophic losses if a stock market quickly plummets
during a downturn in an economy. For example, the U.S. stock markets dropped half in value
during 2008, and many internet stocks became worthless during 2000 as the stock from internet
companies plummeted. Consequently, investors could earn capital losses if they sell their stock
as it falls in value, or the corporation bankrupts.
Corporations can use subsidiaries to avoid regulations or avoid taxes. For instance, a parent
corporation could relocate to the Bahamas or Cayman Islands. These countries are tax havens
with low taxes, little regulations, and strong confidentiality laws. Consequently, corporations
can shift assets and liabilities among subsidiaries to decrease their overall tax burden. At this
point, we clarify some tax terminology. Tax evasion is a person or corporation owes a
government for taxes, but refuses to pay it. Some activity created the tax liability, and the law
requires them to pay taxes. Otherwise, government can assess fines or send the tax evaders to
prison. However, corporations can use tax avoidance because they can afford to hire specialists.
Tax avoidance is the managers careful plan the corporate activities and prevent the creation of
tax liabilities.
Dividing line between tax evasion and avoidance can be a thin one. Since the 2007 Great
Recession is still impacting the world economy in 2013, some tax authorities penalize and fine
companies that use tax avoidance. Unfortunately, tax collections are down, and many
governments are becoming aggressive in tax collections. For example, Italian tax inspectors
board yachts as they dock in Italian ports. Italian yacht owners registered their yachts in the
Cayman Islands, avoiding registration fees and avoiding the VAT fuel taxes. Consequently, the
Italian ports reported 40% declines in yacht docking as the yacht owners avoid Italy’s ports.
Unfortunately, the economies around the ports suffer from fewer customers, who shop and eat in
the local communities, which could further depress tax revenues.
Corporate Fraud
The Enron Corporation declared bankruptcy in 2001 and became the universal symbol for
corporate fraud. Enron managers created Special Purpose Entities (SPE) with the sole purpose to
wipe debt and liabilities from Enron’s financial statements. A Special Purpose Entity consists
of a company or subsidiary of the corporation. A SPE could be a shell company, where the
company does not physically exist, except on paper.
The Enron managers invested in many power plants around the world, and some of its
investments soured and failed. Then, they created off-balance sheet companies, and they sold its
bad investments to its SPEs. Afterwards, their balance sheet appeared financially strong, and
Enron applied for more bank loans, gaining more cash. Next, the Enron management bought
more companies, and they repeated the process. At the end, Enron hid $25 billion in debt from
its investors.