Monday, February 11, 2008

Financial Journalists Who Don't Understand Finance

Dagens Nyheter has a story where journalists Patricia Hedelius and Dan Lucas "reveal" how the Swedish government would lose hundreds of millions of Swedish kronor in tax revenues if it privatized alcohol wholesale company and producer Vin & Sprit (whose most famous brand is Absolut Vodka).

The reason is supposedly that today Vin & Sprit does not use a loophole in the Swedish corporate income tax law which would have allowed them to reduce their tax payments by hundreds of millions of Swedish kronor. If however the company were privatized then it would most likely use that loophole, thereby allegedly depriving the Swedish government of all these money.

It is appalling but not surprising (given my past experience of them) that financial journalists does not seem to understand basic principles of finance or business administration. Namely in this case that the value of a company is related to the present value of its future net profits and that it therefore is irrelevant for the Swedish government whether companies it sell can use a well-known and predicted tax loophole.

The reason why Vin & Sprit today does not use that loophole is most likely that it would be meaningless for them to do it. A company is supposed to act in the interest of its owner, in this case the government. And it would really be pointless for them to try to use tax planning since the money is going to the government anyway-whether in the form of taxes or dividends. For a private company the situation is different of course and in their case it is basically the duty of the corporate management to use tax planning to minimize the tax cost. This is probably what these journalists focus on. However, what they neglect is the basic fact the price the government will receive in its privatization is related to the expected future net profits. And because this loophole exists, investors will be willing to pay a lot more for the company than they would have done if the possibility to use this loophole hadn't existed. How much more? Well, basically equal to the present value of the tax reduction, meaning that what the government loses in tax revenues they gain fully in a higher sales price for the company.

These incompetent journalists apparently haven't thought about how much investors would have paid for the company if a 100% tax rate -without any loopholes- had been applied. The answer is of course zero (At least if you set aside possible perceived benefits of gaining operational control of the company). And the same principle applies to any taxation of companies that will be privatized. Because of the fundamental principle of finance that the value of a company is equal to the present value of its future profits, expected future taxation of these companies have the same financial effect on the government as taxation of government owned companies. That is, none at all.

In a rational world, financial journalists would be required to understand that. But apparently they aren't, at least not at Dagens Nyheter.


Anonymous PELLE said...

Theories are great tools, and wouldn't it be lovely if they worked in the real world!?

However, as you should have learned by now Odell is not very competent and definitely not at all rational. This sale is an ideological decision, NOT a rational and economically sound one. You can rest assure that if the DN reporters wouldn't have brought this loop hole to the light, he would not have included it in the calculus and the buyer would have gotten a huge rebate on the expense of the Swedish people. Thank God for these journalists!

10:55 AM  
Blogger stefankarlsson said...

Well, pelle, maybe Odell and his staff are incompetent too, maybe they aren't. But if they are as incompetent as you say how do you expect them to figure out that this loophole makes the company more worth when the journalists themselves didn't figure it out? Let's hope then that they read this blog.

3:19 PM  
Blogger Graeme said...

I used to blog about this, but gave up after a few posts because there were so many more examples than I could possibly cover.

Journalists do not understand things like the difference between a loss due to a goodwill write-off and one that actually means cash flowed out.

Jouranlists all aropund the world seem equally bad, and they seem just as bad covering any subject. IT is almost as bad, science coverage is worse, and I am sure foreign coverage of your own country (or one you know well) will often show swtartling ignorance.

7:21 AM  

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