Essay On The Rise And Fall Of Dick Smith Holdings Limited.

Issues surrounding the prospectus for fundraising in 2013

Write a  Report on the Rise and Fall Of Dick Smith.

There have been many issues surrounding the management of multinational corporations in the recent past.  The issues range from poor corporate governance practices, manipulation of a corporation’s books of accounts and lack of transparency in financial reporting. The aforementioned factors together with ethics in decision making are very important things that ought to be observed when it comes to management of a multinational company of Dicks Smiths kind. The spectacular fall of Dick Smith Holdings Limited in 2016 really sparks many questions about the role of the management in ensuring shareholders wealth is maximized. While the root issues surrounding the collapse of Dick Smiths Holdings limited may be attributed to inventory changes and an untimely equity floatation of the business, a more inquiry into the affairs following the fall shows a broader scope on the issues of disclosure that might have been avoided by the company’s Directors and management (ABC News, 2018). More importantly, a critical analysis of the prospectus issued in 2013 shows that very little information about inventory was disclosed. The Australian Corporations Act stipulates all the pertinent information that should be disclosed by a prospectus before its issue for any fundraising. Dick Smith might have failed to disclose all the details of the financial statements which are required by the investors and their professional advisors in reasonably making an informed decision regarding the purchase of the company's shares. AASB and ASIC are bodies that further outlines the regulatory guidance that is meant to protect the interest of the investors and creditors in a company.  This paper intends to analyze critically the circumstances leading to the rise and fall of Dick Smith Holdings Limited since it was acquired by Anchorage Capital Partners in 2012 and the eventual eminent fall in 2016 and report on the findings.  To do this both quantitative and qualitative information from a number of sources will be integrated into the report. Moreover, corporate governance principles that might have been violated by the management of Dick Smiths Holdings Limited are reviewed.

In the business world of today, it is common to find corporations trying to ‘‘dress up’’ the company to look like it is performing well financially so as to persuade people to buy shares from it. The prospectus for selling shares in 2013 by Dick Smith might not be far from this. According to insider information from the company, Dick Smiths management is suspected to have manipulated the stock inventories and sales figures of the company to look that the company was making progress and yet that was not the case (Yeates, 2018, np.; Montgomery, 2018, np). This saw the company purchasing excessive levels of inventory so as to aggressively fulfil the alleged rapid expansion of stores and thereby calling for rebates from the suppliers as a way of boosting earnings in the short run.

Malpractices in the 2013 prospectus fundraising

Since Dick Smith had been transited from being a subsidiary of Woolworths to the ownership of a private equity owner- Anchorage Capital, there was an increased pressure to the listing of the company on the Australian Stock Exchange (The Conversation, 2018). Keeping in mind that Anchorage Capital had purchased the company at $ 115 having paid only $ 20 million in cash, there was a big desire for the company to realize a high stock price when it was listed and hence a significant profit from the sale of shares. This aggressiveness for profits of share price was the beginning of failures for the electronics company (Yeates, 2018, np.).

As of November 25, 2012, the inventory account for Dick Smith was at $ 370 million. Just the day after, on November 26^th, the inventory was written down to a tune of $ 58 million bringing down the accounting figure to $ 312 million. This write-down gave the company a ‘‘false'' profit figure of $ 58 million on the profit and loss account. To add insult to the injury, the dubious write down was never mentioned in the 2013 prospectus despite it being one of the material information required to be included in a prospectus. Moreover, the report was never mentioned in the auditor's report by Deloitte as the investigating accounting firm (Montgomery, 2018, np.). Nevertheless, the management of Dick Smith is guilty of not disclosing all the material information as required by the law.

A number of researchers have exposed the ‘‘evils’’ the management for many corporations usually do regarding the information contained in a prospectus. An individual research conducted by Campel Harvey, Shiva Rajgopal and John Graham on executives in Australia revealed that close to 78% of them admits considering sacrificing the long-term value of the company for the sake of getting quicker ‘‘smooth'' earnings (Graham, Harvey and Rajgopal, 2018, np.). This is a worrying trend that could jeopardize the economic conditions of a company and the overall economy of the country. ASIC and the Australian Competition and Consumer Commission (ACCC) requires companies to use ethical means of acquiring earnings ((Asic.gov.au, 2018, np.; Bolt, 2004, pp. 85). This means that Dick Smith violated a number of consumer laws in its issue of the prospectus in 2013. AASB also requires managers to maintain a constant predictability of earnings in the financial statement disclosures (Carlin and Finch, 2008). This is required so that there is a reduction of information risk that can boost or reduce the price of stocks. The management of Dick Smith appears to have set the prospectus disclosure at a position difficult to be maintained.

The role of AASB and ASIC in fair value disclosures

The Australian Corporations Act contains a general provision for disclosure tests that should be conducted on a prospectus. The Act provides that for a prospectus to be valid it must contain all the pertinent information that investors and professional stock analysts deem reasonably necessary to be provided and can affect their decision during the assessment of the share price prospects of the issuing company. The regime of protection of investors is therefore offered by the law and the shareholders can feel pain for having being denied their rights to get all the relevant information as clearly enshrined by Corporations Disclosure Act. (ABC News, 2018) Since the information contained in the prospectus for Dick Smith Holdings was corrupted, financial consultants could have found it difficult to offer informed advice to their clients. The prospectus for Dick Smith Limited, therefore, was made of distasteful elements.

There are a number of strategies today that unethically motivated managers employ today in order to meet short-term organization targets. Most of these strategies are against good corporate governance practices and can have detrimental effects on the value of the firm in the long run. The most common are:  

Real Activities Management

 It is very common to find that most private equity owners are usually undertaken primarily with an aim of increasing the value of the firm within a short time. This is normally done through the selling of non-core company assets and discontinuation of some unprofitable business segments as a way of looking to improve the efficiency of the business operations. However, this was not done for Dick Smith. Instead, the management sought to employ dubious accounting methods such as the use of rebates so as to make the value of the company appear as better (Montgomery, 2018, np.). This strategy has been referred by accounting researchers as “real activities management”.  Real activities management is the divergence of the management from the ethical standard operation procedures of a company to the restructuring of transactions so as to alter the financial results and hence misleading both the existing and prospective investors of the company through the financial reports (GUNNY, 2010, pp 870). Since real activities management makes use of ‘‘legitimate’’ transactions away from the interpretations of the existing accounting standards and the Australian Corporations Law, it is difficult to be detected and it can be easily integrated into the normal day to day business operations of the company. Real activities management, however, has been identified to eventually lower the value of the company in the long run.

The practice of manipulating the sales figures, accounts, and stock inventories of the company

Earnings Management

Apart from real activities management, there is also another management malpractice referred to as earnings management (EM). The strategy involves myopic reduction of the research and development expenditures, price discounts and ‘‘timely’ ’sale of the fixed assets of the company so as to meet short-term earnings targets. This has an effect of over-production or overstocking of inventory in order to lower the cost of goods sold and hence indicating that that financial results of the company are positive (GUNNY, 2010, pp 860). Despite it being risky, earnings management has been found to be one of the commonly used malpractice tools of management in the attainment of earnings benchmarks (Graham, Harvey and Rajgopal, 2018, np.). Both Earnings Management (EM) and real activities management (RAM) have negative trackable impacts on the value of the company.

Manipulation of Book of Accounts

The accounting practice is usually guided by a code of ethics that requires professional accountants to act in the best interest of the public by providing their services diligently, professional and with due care. Since the fall of Dick Smith in 2016, the accountancy profession has been put on the spot on their role in providing a ‘‘caveat emptor’ ’on the financial performance of the company (Malley, 2018, np.). The accountant code of practice also requires that accountants should be able to navigate all kinds of complex business environments by making decisions regarding treatment of revenues that not only comply with AASB and IFRS requirements but also in conformity with the spirit of what the company is seeking to achieve (Aasb.gov.au, 2018). It is because of the ubiquitousness of the accountants and the management at Dick Smith that lead to lack of consistent transparency and hence the loss of jobs of close to 3300 employees and billions of dollars to the investors who lost their money.

The main problem that might have seen a false financial position at Dick Smith has been identified to the issue of rebates from suppliers. This practice is what influenced the management to purchase excess amounts of inventories with the motive of making an increase in earnings (Financial Review, 2018, np.). Between 2014 and 2015, Dick Smith reported $ 72 million as earnings before interest, depreciation, amortization and tax. If the issues of rebates and advertising subsidies claimed by the company could be excluded, the profit figure could be adjusted downwards resulting to a loss of $ 119 million EBITDA (Malley, 2018, np.). It is therefore evident that the failure of Dick Smith is a result of the accounting treatment of rebates.

Poor Corporate Governance Arrangement Issues at Dick Smith in Financial Reporting

When it comes to ethics in decision making, managers are required to make many organizational decisions that can pass through the ‘‘ethical funnel’’. Research has shown that only a few managers are ethical in their decisions and are able to pass through the ethical funnel (Prempeh and Odartei-Mills, 2015). Ethics requires that managers should be guided by ethical values to ensure that they provide financial statements in reporting that reflects the true and fair view of the company's statement of financial position. Good corporate governance practice also requires that managers:

• Should not exaggerate the quality or the durability of the products they deal with.
• Should assist in protecting and correcting the environment in which they operate without the supervision of relevant authorities or demands from the public (Ceil, 2012).
• Should not exaggerate the cash flows of the company they manage by ‘cooking’ books so that the firm appears to be performing well and hence getting lower interest on loans from banks and higher quotations of the firm’s stock prices and yet that is not the true case.

It is however sad to discover that the above issues were never adhered to by the management of Dick Smith. In any other organization, corporate governance practice should clearly separate the duties of the different stakeholders so that every party should discharge their duties and responsibilities according to the relevant professional standards required of them (Rankin, Stanton, McGowan, Ferlauto, & Tilling, 2012, p. 188). At Dick Smith, this appears to have not been the case, and the management might have colluded with the directors in ‘‘cooking’’ the books of accounts.

Act Ethically and Responsibly

The principle of ‘‘Act ethically and responsibly’’ requires that the management should always act in a manner that the company is going to become better so that the investors and other stakeholder’s interests are going to be fulfilled (Asx.com.au, 2018, np). This principle with the normative stakeholder’s theory. For Dick Smith, management should have acted in the best interest of the company’s stakeholders a fact which should not have seen the collapse. The management never acted ethically in the issue of the prospectus and in the treatment of the rebate item in the books of accounts before the inventories were actually sold. This eventually led to the eventual massive loss of funds belonging to the shareholders.

The Principle of Timely and Balanced Disclosure

Good corporate governance practices require managers to make timely, accurate, transparent and balanced disclosure of information during financial reporting. A balanced disclosure of financial statements means that the information contained in the report should reflect a true and fair view of the company’s financial position. (Rankin et al., 2012, pp. 193). The timely and transparent disclosure also helps the stakeholders to make informed decisions regarding whether to buy or sell shares. Dick Smith never provided a true picture of the financial situation of the corporation. The principle of timely and disclosure is in line with sentiments of the legitimacy theory which propounds that a company should be legitimate in social and environmental reporting (Charpac.com.au, 2018, np.).  The management of Dick Smith is alleged to have diverted the financial disclosure role to suit their own short-term selfish interests of bonus pay.

The Principle of Recognition and Management of Risk

The corporate leaders for Dick Smith Limed failed to form a structure for risk recognition and management for the corporation they run. This was against the corporate governance principle of risk recognition and management why requires that aspects of risk are realized and dealt with using internal controls that are set by the management (Shen, 2010, pp. 87).  If the managers of Dick Smith could have looked at the risk profile of the company earlier, the company could not have collapsed. Risk recognition and mitigation play a very important role in financial management. As supported by the agency theory, the management is the agents of the shareholders and they are supposed to do all it takes to ensure that the company continues in operation into the foreseeable future without having to wind up its operations (Zhang, 2009). The move by Dick Smith to write off $ 60 million in 2015 which indicates that the risk profile for inventories was never considered.

Appointment of Administrator, Receiver, and Liquidator

When a company is in a financial difficulty, the secured creditors and the Board of Directors may decide to put the company in a receivership. This means that company is in liquidation. In this case a receiver manager and an administrator are appointed. A receiver manager is a person who is entrusted by the creditors to manage the affairs of the company soon after liquidation (Asic.gov.au, 2018). The Board of Directors also have to appoint administrators to take over the management affairs of the company henceforth. As for Dick Smith,  Joseph Hayes, William Harris, Matthew Caddy and Jason Preston were appointed as voluntarily administrators while Ferrier Hodgson, Jim Steward, Ryan Eagle and Jim Sarantinos as the receiver managers. The administrators and the receiver managers were required to secure the business operations of the company following the fall and also to investigate the issues surrounding the collapse of the giant electronic retailer. The receivers and administrators were also required to report their findings to the Australian Securities and Investment Commission (ASIC) on the possible violations that were made by the company’s management leading that led to the fall.

The Position of Dick Smiths Creditors Regarding the Receivership and Liquidation

There are two types of creditors according to the corporations Act, the secured and the unsecured creditor. A secured creditor is an individual or a business whose money is owed by another person for providing goods, service or finances but does not have security attached to it. A secured creditor is the one who has lent funds and have a security attached to the money lent. During liquidation, the secured creditors are paid first and the unsecured have to wait for the secured to be settled.  Moreover, secured creditors have a big role in voting for liquidation’s per the provisions of Australia’s Corporations Act and AASB, the creditors of Dick Smith decided to for the winding up of the company. This move was meant to facilitate recoupment of the losses they had incurred in their lending’s to the company. It is estimated that the total amount that was owed by Dick Smith amounted to more than $ 260 million. One of the administrators - McGrathNicol took over as the liquidator for companies after the creditors had voted in favor of their liquidation (The Sydney Morning Herald, 2018, np.).

The Duties of Directors During Insolvent Trading

Directors usually have a big role in ensuring that the company is always solvent and will remain solvent.  To do this, the directors have a duty to constantly assess the level of risk by taking caution when expanding the business operation of the organization. As for Dick Smith, it can be said that the general and departmental directors actually failed in their duties of guarding the interests of the creditors, the employees and the shareholders.

In case a corporation goes into liquidation and becomes insolvent, there are various consequences and penalties that are stipulated by Australia’s company’s Act and AASB to be taken against the individual directors. This involves, compensation, criminal charges and even civil charges against the directors. Australia Corporations Act also provides some defenses incase issues surrounding the insolvency of the company are economic (Legislation.gov.au, 2018). The Directors of Dick Smith appears to have make use of this provision to defend themselves that the company had suffered from cyclic economic variations. Questions however arises on why they could not take appropriate steps to mitigate such seasonal risks. They should have also kept themselves in touch with the company’s management to ensure that organization has a sound financial position. ASIC Information Sheet 42 and ASIC Regulatory Guide 217 stipulates that directors who violates their duties of preventing the company from insolvent trading should be fined up to $200,000 (Asic.gov.au, 2018, np).

Conclusion

To sum up, it is evident that there a number of issues that led to the fall of Dick Smith Holdings Limited. Most of the issues touched on poor corporate governance practices, low level of transparency in financial reporting, manipulation of sales figures and cooking of books of accounts. As discussed above, the failure could have been avoided had the management of the company measured and mitigated risks at an early stage. Cheating I the information of the prospectus issued in 2013 also led to the imminent failure. As shown by other researchers, problems to do with bad governance practices is on the rise among multinational companies in the world of today. From our own investigation, it is clear that Dick Smith was also greatly affected by the same.

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