Risk Management at Ahold
Started as a small grocery store in the nineteenth century, Ahold has become a well-known multi-national with several thousands of operated stores in approximately 27 countries. With (reported) all-time high sales and profit of more than ( 66 billion and ( 1. 1 billion in 2001, Ahold is today one of the largest retail and food-service companies in the world. Ahold was one of the success stories of the 1990’s. Until the end of the 1980’s, Ahold was a family controlled national business with strong protection of the family shares. During the following decade, the company transitioned towards a management controlled firm.
This transition appeared to be everything Ahold needed. The new management initiated an aggressive growth strategy, acquired many international companies and became a global player. Ahold was the example how to run a firm. Early in 2003, however, Ahold was knocked off his pedestal. A failing strategy became apparent, accompanied by accounting fraud, self-enrichment by executives, a non-functioning board of directors etc. , eventually resulting in many legal charges throughout the whole world. The market just had recovered from scandals like Enron and Worldcom when this hit the market again.
What frightened most investors was that this time it was
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With hind sight, it is clear that a company like Ahold was engaged in some very risky business situations, and that it was just a matter of time before something had to surface. This paper will elaborate on the various kinds of risks and the possibilities to manage them, also specific to the situation of Ahold. Risk management entails assessing and managing the corporation’s exposure to various sources of risk through the use of financial derivatives, insurance and other activities. Before we will analyze the risk exposure of Ahold in specific, we will assess the area of risk management in general.
[Grinblatt, Titman, 2002] Unknown before the 1980’s, risk management has become one of the most important responsibilities of treasurers in large corporations throughout the world. In theory, protecting the firm against unexpected and unwanted changes in relevant factors, hedging, will not create value for the firm according to the Modigliani-Miller theorem, just as with capital structure. However, when the underlying assumptions are relaxed towards reality, hedging (as part of risk management) can improve the expected cash flows (and therefore the value) of the firm.
This improvement could be the result of the minimization of the variability of the cash flows, although it has been argued that eliminating the probability of costly scenarios is the primary goal of risk management in particular (Stulz, 1996). The growing attention towards these types of risk originated at financial companies, but are important to non-financial companies as well. Bartram (2002) reports a significant interest rate exposure of non-financial corporations with regard to changes in the short-term and long-term riskless interest rate as well as the interest rate spread.
A large number of these firms even tend to have an important nonlinear exposure component, which will require more advanced risk management instruments. Another fundamental element of risk management is the ability to cope with movements of the foreign exchange rates. Lee et al. (2001) found that companies may practice risk management by attempting to forecast these movements and use the forecast to formulate alternative strategies (Davis et al. 1991). However, personal judgment still plays a major role in these forecasts and the accuracy of forecasting is questionable (Lee et al.
2001), explaining the increasing use of over-the-counter forward contracts to hedge the risk (Marshall, 2000). These types of risk are directly related to the financial situation of the company and are relatively easy to quantify, explaining their popularity the past two decades. A company like Ahold will be exposed to all these risks. Taking into consideration all the worldwide acquisitions during the past decade, Ahold’s investments (largely financed by debt) and sales will be quite sensitive to fluctuations in the global interest rates and currency rates.
In addition, operating in a very competitive, high-volume low-margin business, Ahold will also be sensitive to fluctuations in the prices of the commodities itself. But, as many businesses are experiencing during the aftermath of the booming 1990’s, there are more aspects to risk management than these (pure) financial types. Especially after the surge of takeover activity, several other types of risk are getting more and more attention. Growth is an almost inevitable part of the strategy for most companies.
A firm can grow by expanding its current plant / subsidiary, by establishing new plants / subsidiaries, or by diversifying into new businesses. However, as such strategies reposition the borders of the firm’s operations, it can lead to unexpected situations. A known example of such strategy risk is the failure to integrate the acquired companies leaving the promised benefits unutilized. In such situation, control risk is closely related to strategy risk. Not effectively integrated subsidiaries can start a life on its own, out of reach and out of sight of the new owner.
Some research has been done on the sources of this kind of organizational problems. Tan (2003) identifies managers with internal and international experience as one critical input for a firm’s overseas expansion, and present supportive evidence. Slow managerial growth (of substantial quality) is considered to be a major constraint for fast growing multinational companies. If we project this on the Ahold situation, you could argue that the mismatch between the growth rate of the firm and the growth rate of its management is one of the factors leading to a lack of unity and control.
Newly acquired companies were not always brought ‘up to speed’ by experienced Ahold managers about the values and ‘do’s and don’ts’ of the overall Ahold company. Not being thoroughly fitted in from a managerial point of view, Ahold was exposed to risk of losing control. The subsidiaries had a relatively large degree of freedom to proceed with their own way of doing business, out of sight for the directors of Ahold. With the increasing volatility of the (stock) markets and the increasingly demanding shareholders, the risk of damaging a firm’s reputation has become even more important the last decade.
Exposure to reputation risk can lead to disobligingly shareholders, reluctant investors and boycotting customers. When even the creditworthiness is at stake, reputation risk can result in a significantly increasing exposure to interest rate risk because of an increasing default spread. This is what happened to Ahold in 2003: when the malversations were discovered, almost immediately the credit rating of Ahold was adjusted downwards. This caused the share price to crash leading to a staggering debt-to-equity ratio, and solvency problems for the outstanding debt.
In addition, after the situation was stabilized in 2003 the reputation of Ahold got another blow: the extraordinary compensation for the new CEO. When the boycott of customers started to gain momentum, the new CEO abandoned his lucrative package wisely. For long, international diversification has been considered an effective way to reduce operational risk. Cross-border acquisitions soften the net result of all demand characteristics in end-product markets as well as irregularities in supplier markets.
In addition, availability of critical technological resources can be secured in a more effective way by diversifying among businesses and markets. However, Seth et al. (2002) warn for value destroying cross-border acquisitions driven by managerialism: managers of acquiring firms embarking on acquisitions in order to maximize their own utility at the expense of the shareholders of the firm. This is interesting when projected on the Ahold situation.
Many acquisitions were said to be driven by the benefits of increasing and diversifying the operations with respect to geographical location as well as the type of business (‘normal’ retail vs. on-line delivery service, upmarket formulas vs. price fighter formulas). With hind sight, some analysts have been questioning to what degree the acquisition strategy was driven by the desire of management to be applauded by the market for spectacular growth and to prolong the glorification of the CEO’s personality in particular. In our following discussion, we will elaborate on the Ahold situation with respect to these kinds of risk exposure.