Assets: Any possession that has value in an exchange Tangible assets: value is based on physical properties - land, buildings,

machineries, vehicles Intangible assets: legal claims to future benefits - Financial assets, instruments, securities Derivative Instruments: Value is derived from the value of the underlying financial assets. Futures and options Roles financial assets play? Transfer funds from surplus units to deficit units Reallocation of scarce resources from non-productive to productive use Pooling of funds Management of risk: pooling, sharing, transferring Types of financial assets Debt - Fixed payment - Bank loans, Govt bonds, Corporate bonds Equity - Payment is based on earnings - Common stk, Preferred stk Other types of financial securities Derivatives: forwards, futures, options, swaps, Commodities, Securitized assets, Credit derivatives Properties of financial assets Moneyness (money or near money) Money: medium of exchange: cash or check (demand deposit or current account) Near money: saving deposits, fixed (or time) deposits, T-Bills Divisibility and denomination (minimum size for liquidation or exchange for money). Deposits: infinitely divisible Lots of shares: 100 share (US), 1000 share (Singapore) T-bills and bonds: $1,000 Reversibility or round-trip cost (cost of getting in and out) Bid-ask spread - Difference between the price where the market (or market marker) is willing to buy and sell. Function of risk 1. Commission or brokerage fee 2. Stamp fee/duty 3. Loadings 4. Term to maturity (time interval to final payment)

Demand instruments: Payment at anytime checking (demand) and savings account deposits. Infinte to maturity: Perpetuity or consol (UK), Equities Short term: T-bills Long term: Bonds 8. Liquidity (thickness of the market) Loss due to immediate liquidation Number of ready buyers and sellers Depth of the market Affects the bid-ask spread 1. Currency Exchange rate exposure and risk Risk 10. Risk and Uncertainty: Risk is the measurement of the uncertainty of the occurrence of an event Measure of risk: Volatility: variance, standard deviation, beta Financial mrkts Structure where financial assets are exchanged/traded Role of financial markets Price discovery process - Determination of price or return of financial assets. Influence by many factors (eg. liquidity, risk, information, transaction process) Provision of liquidity -Provide a place of gathering of willing buyers and sellers Reduction of transaction costs - Reduce search time and cost. Reducing contracting cost and risk Types of financial markets Primary: New Issues, Private placement, IPO and SEO Secondary: Trading of issued assets Debt, equity, or derivatives Money Markets Short-term: 1 year or less - Federal funds and discount windows, T-bills, Short-term municipal securities, Certificates of deposits (negotiable and nonnegotiable), Repurchase agreement, Commercial papers Capital More than 1 year - Stocks and bonds

Exchange or OTC Spot or forward, future Investment banks -Financial institutions that engage in public and private market transactions for corporations, governments, and investors Examples of market transactions: Fund sourcing: Issuance of equity and debt securities, Mergers and Acquisition or M & A, Divestitures Other activities: Proprietary trading: trades on its own capital, Securitization: pooling and repackaging of financial assets into securities, Financial engineering: using mathematical and numerical methods and simulations to create financial products, or to make trading, hedging and investment decisions, Investment management: helping individual and institutions to invest, Prime brokerage The offering of tools and services to clients to support their operations in trading and portfolio management. The offering of services, such as lending of securities and funds, to hedge funds and other professional investors to support their investment strategies Types Of Investment Banks Financial holding companies Large financial companies, under universal banking, have always existed in places other than the US. Gramm-Leach-Bliley Act 1999 created large financial holding companies in the US Examples: HSBC, Deutsche Bank, UBS (?), Citigroup, JPMorgan Chase, BOA Financial holding companies, Businesses includes: Retail (or consumer) banking, Corporate banking, Investment banking, Asset management, Wealth (private) management, Credit cards Full service (bulge bracket) inv banks: Goldman, Morgan - FHC Boutique houses Sandler ONeill: Specializes in financial institutions (provides research, acts as market markers, trading), Full service investment bank Greenhill: Specializes in M&A and financial restructuring Lazard: Specializes in M&A and asset management Number of investment banks: SINGAPORE

Local: 3 (under the 3 local banking holding groups), Others: 44 (called merchant banks) Activities: Normal investment banking activities, Operate in Asian Dollar Market through their ACUs, No SGD deposits or borrowings from the general public, Can accept SGD deposits or borrow from banks, finance companies, shareholders, and companies controlled by their shareholders Regulation to deregulation to re-regulation to .. The financial industry has always been oscillating between regulation and deregulation. Regulation leads to orderly market practices but hamper growth and competition. Deregulation on the other hand promotes growth and competition but give room for abuse and misuse and ultimately cause too much damage to the market. Striking a balance is the responsibility of regulators. Two schools of thoughts: A dynamic optimal balance exist and the regulators are responsible to locate it and keep it current. Only minimal regulation is necessary. The illusion of the existence of an optimal system will only delay the occurrence and increase the intensity of crisis and hence do more harm than good. There is no perfect system against the innovativeness of the human mind. General long term trend is towards less regulation as market matures Deregulation: UK: Big Bang Margaret Thatcher government's reform program in the 1980s to deregulate the financial market London, once a global financial centre was losing ground to New York . Problems: overregulation and the dominance of elitist old boys' networks Solution: free market doctrines of unfettered competition and meritocracy. Results: London is still one of the most important financial centre in the world Japan: Big Bang Financial reforms in the late 1990s. In reaction to the deteriorating condition of the economy and financial sector. To open up Japans banking, insurance, pension, and stock exchange to global competition. Japan Postal system reform. Up to 2007, Japan Post offers postal services, banking services, and life insurance. One third of all government employees worked for the Post. Largest saving system: US$3.2tr Privatize in 2007: Split into 4 units (Japan Post, Network, Bank, and Insurance) Singapore: Privatization of POSB. Opening competition for the banking sector. Relaxing control of S$

 Gramm-Leach-Bliley Act vs Glass-Steagall Act Glass-Steagall Act 1933: In the light of the great depression. To curb conflict of interest. Commercial banking, investment banking, and insurance activities cannot be under the same roof. Lead to the break up of big banks. Example JP Morgan and Morgan Stanley Gramm-Leach-Bliley Act 1999: Repeal of the Glass-Steagall Act occurred in steps. 1987: Fed allowed banks to underwrite and deal in Tier 1 securities: commercial papers, munis, MBS, etc. 1988: Fed allowed banks to underwrite and deal in Tier 2 securities: all types of debt and equity instruments.1989: underwriting revenue cap raised from 5% to 10% of total revenue. 1997: underwriting revenue cap raised to 25%. 1999: Total repeal of Glass-Steagall Act Gramm-Leach-Bliley Act 1999 created large financial holding companies in the US. These are big banks with underwriting arms initially known as Section 20 subsidiaries. Gramm-Leach-Bliley Act 1999: Deutsche Bank bought Morgan Grenfell. UBS bought Swiss Bank Corp and thus Dillon Read and Warburg. Citigroup bought Travelers Group and thus SmithBarney. The repeal of the Glass-Steagall has been under attack since the subprime crisis began TRENDS 1. Globalization Tapping overseas market for growth. Emerging economies swell opportunities. First mover advantage. Challenges: Political instability Regulatory biases and prejudicial changes and protectionism - SGX & ASX, Asean Trading Link, Cultural differences 2. Advance in technology Information, Settlement system from T+5 to T+3 to T+1, Algorithmic trading,Internet trading 3. Diversification Financial institutions, especially investment banks, have become more diversified. Financial holding companies are diversified behemoth (thanks to Gramm-Leach-Bliley). Investment banking represent a smaller and smaller portion of total income . Other

income sources: trading, hedge funds, securitization, asset and wealth management, prime-brokerage, credit cards Measure of Performance Income sources Underwriting spread, M&A fee, Trading profits, Prime-brokerage (interest and fee), Market making (spread), Research Risks Market risk Interest rate - Trading in fixed income securities Security prices - Trading in stocks, commodities Forex - Forex exposure Credit risk Counterparty default risk: swap, derivatives, credit derivatives. Prime-brokerage: Hedge fund failures, Issuers default: MBS, bonds, commercial papers Operating risk Settlement and clearing Entry errors Legal Tons and tons of regulations - other than all the different acts: fair disclosure, money laundering, funding of terrorists, etc Liability law suits: eg Enron, WorldCom Funding risk Borrowing: capital and money market The credit squeeze Liquidity risk The inability to liquidate immediately at fair value Private Equity: Investing in the equity of a private business. This involves holding an equity stake in companies (called portfolio companies) that are mostly not publicly traded. Setup: Private partnership General Partner: a private equity firm holding the control power Limited Partner: institutions or wealthy individuals (passive partners) Types of investments: Equity investments Leverage buy-outs: buying a major equity stake Venture capital: major stake in less mature firm

Growth Capital: minor stake in more mature firm Private Equity Fund Pooling of resources to invest in a portfolio of assets. Funds can be specialized or diversified Specialized funds make use of their superior knowledge, information collection and processing capabilities to earn abnormal returns Diversified funds invest in less correlated assets to reduce idiosyncratic risk. Decision to add assets depend of their impact of the risk and return structure of the portfolio Fund of funds - Invest in private equity funds as though they are individual assets. These funds of funds normally hold a diversified portfolio of private equity funds. Factors affecting choice of funds to add include Correlation with the existing portfolio, Track records, Strategies Experience, Liquidity: hold-up periods, average holding period time, exit options. Managers of fund of funds will monitor the running and the performance of the funds in their portfolios closely Investment banks can be involved in private equity Operating private equity funds or firms: eg, Goldman Sachs Principal Investment Area, JP Morgan Partners, and Bank of America Equity Partners. Raising capital for private equity funds, venture capital funds, LBO funds, and fund of funds. Raising capital for private equity firms Returns are generally believed to be higher than other asset classes Private equity business normally will lead to other types of businesses: eg. future underwriting business and M & A Big names Private Equity firms: TPG, Goldman Sachs, Carlyle Group, KKR, Blackstone Group, Apollo Global Management, Bain Capital. Advantage and disadvantage of listing? Advantages You get access to new capital to develop the business A float makes it easier for you and other investors to realize your investment You can offer employees extra incentives by granting share options Being a public company can provide customers and suppliers with added reassurance

Your company may gain a higher public profile, which can be good for business Having your own traded shares gives you greater potential for acquiring other businesses, because you can offer shares as well as cash Personal guarantees of directors are not usually required for borrowings Disadvantages: Your business may become vulnerable to market fluctuations, which are outside your control. If market conditions change during the floatation process you may have to abandon the float. The costs of floatation can be substantial and there are also ongoing costs such as higher professional fees. You will have to consider shareholders interests when running the company - which may differ from your own objectives. You may have to give up some management control of the business and ultimately there's a risk that the company could be taken over. Public companies have to comply with a wide range of additional regulatory requirements and meet accepted standards of corporate governance Managers could be distracted from running the business by the demands of the floatation process, and by dealing with investors afterwards Valuing private companies are extremely challenging and rarely accurate. This is because No market prices available, Useful data do not exist or is rarely collected, Shorter life of the companies, Information asymmetry or lack of transparency, The slope of the business life cycle Venture capital investments are equity (or equity-like) investment in small and newly start-ups that have high-growth potential. Such firms pose high information asymmetry and are too small to source funds from capital markets (debt or equity). The only sources of funds are personal or bank loans. However, personal sources of funds are limited and bank loans have their disadvantage - small size, no assistance or advice, hold-up problem. Tapping venture capital funds is also not without risk Such investments can be made by high net worth individuals, or institutions either personally or through a venture capital fund.

The equity stake enables the investor to exercise control over the running of the business and ultimately cash-out in an eventual exit, eg. IPO. Venture Capital Life Cycle Fund raising - Most VCs, as in most private equity entities, are organized as a partnership (for tax purposes). There are some who are organized as limited liabilities companies. General partners have the control over the fund and are the managers and investment advisors to the fund. They are more commonly called venture capitalists. These venture capitalists will source for investors who will make a capital commitment. Limited partners are the investors who provide the funding. These could be - High net worth individuals, Institutional investors who can be pension funds, endowment funds, insurance firms, and even fund of funds. Additional capital may be sourced during the life of the funds. How this may be shared by the partners, and if in the event that addition outside partners are sought for, must be clearly spelled out in the initial contract. Most funds have a life span of 10 years. The investment horizon is anywhere between 3 to 7 years. VCs are very selective in their investment. Not many business ideas or startups can mature into attractive re-sellable firms within that horizon. Typical targets have very high growth potential with very high level of intangible assets which have very little liquidation value and hence avoided by tradition sources of funds such as commercial banks. That is why venture capital investments are typically in industry such as technology, telecommunication, life sciences, and biotech. The venture capitalists will sieve out the hundreds of opportunities presented to the fund to pick up those that fit that profile. Because the stakes are high, due diligence has to be conducted before any investment. Once the opportunities are selected, the VCs will call down the funds from the limited partners. Limited partners who have made capital commitment but fail to provide the funds when called will suffer penalties Management of investment The VCs are expected to be very hands-on in the running of the business of the portfolio companies. They are supposed to do all that they can to increase the chances of cashing out within the 3 to 7 years holding period.The managers normally have operational experience in

the industry of the portfolio companies or are financial professionals such as investment bankers. The VCs will typically be represented in the board of directors and have a say about the companys strategies, directions, and financial activities. Management of investment. There are two component of the VCs compensation. The 2 and 20 rule normally applies but may vary according to the current market practices and the bargaining of the different classes of partners. Management fee: typically 2% of the total capital. Profit sharing: typically 20% of the profit (performance based). Losses are shared as well. Usually, the general partners will bear the losses before the limited partners. Management fees are paid regularly but profits are paid according to the discretion of the general partners. Liquidation At the end of the life of the fund, all of the holdings in all of the portfolio companies have to be liquidated. The possibility of a couple of years of extension may be worded in the contract at inception of the fund. Mode of liquidation: IPO: the most desirable Private sale: selling to another investor who are usually institutional investors or even another fund Closing the company is also an option if business fails or is not sufficiently successful to attract a buyer Time frame is the key. Some business may be successful given enough time but venture capital investments work on a tight schedule. Success factors: Good management team - Deep knowledge of the industry and market, Prior successes in similar business endeavors, If such personnel are not currently present, the ability to attract/employ/poach new managers, Group synergy is extremely important, Manage key personnel well. Good valuation and financing, Beware of paying too high a price, Beware of arbitrary multiples, Maximizing return subjected to incentive compatibility, especially of owners. How? Entrepreneurs should be made to invest his own fund, Good valuation and financing - Very often, convertible debt (or the likeness thereof) is used. Why? Incentive compatibility Higher priority to claim. At least interest paid before entrepreneurs can be paid dividends. Tax deductibility of interest payment.

 Risk factors - Information asymmetry, New products/ideas normally have high level of uncertainty, High growth industry arevery susceptible to fast changes: video, computer, photo or image processing, telecommunication, music. Timing of profits: Most new products/ideas only become profitable after a few years of losses. Changes may occur before the profitability period causing pre-mature deaths. Losing of key personnel Types of Investments Start-up Investments - Seed money: for feasibility study, Product development and market study, Marketing, Working capital Growth-stage or middle/late-stage injections - Depending on the industry and the product/idea, it is not uncommon for firm to seek venture funds only during the expansion stage. A hot product is more palatable than a potentially hot product or idea. Entrepreneurs and existing shareholder will have more bargaining power at this stage. Some very successful ones will have more than one venture funds courting them. Growth-stage or middle/late-stage injections. Negotiation will be more tedious and tricky as there are more parties to satisfy and more interest to align. VCs must be careful to conduct due diligence and not be pressurized to commit. VCs must resist the temptation to be too optimistic and end up over paying. Buyouts: Not to be confused with LBOs. These are much smaller in scale. Involve thriving businesses whose shareholders are seeking or willing to cash out. These may be due to important partners or key personnel leaving (due to death, or personal reasons) or parent company changing direction. VCs must be cautious against adverse selection problem?? Exit Strategies Exit options have to be carefully negotiated and clearly stated in the initial contract. VCs will normally have control over the timing (when to sell), how to sell (private or public), the underwriter in the case of public sale (who to sell), and the buyer in the case of private sale (who to sell to). Private sale - Selling to another investor: high net-worth individual, another fund, or institution. IPO - VCs will normally have strongly preferred underwriters. Rule of when they are allowed to sell their shares after a public offering depends on the regulations at the place of sale. If the venture fund is within an investment

bank, the bank may choose to keep a portion of the share after IPO under their asset management or trading arm. How much of the shares they keep may signal how confident they are about the stock. What are Leverage Buyouts Private equity transactions that use leverage extensively to acquire a controlling equity stake of the target firm. In the extreme, 100% of the outstanding shares of a listed firm may be acquired, i.e. taking the public company private. Leverage increases the returns for the buyout fund (or private equity firm) due to: The buyout fund does not need to expend all their funds in the deal. Interest are tax deductible. Effect on ROE. The leverage level can range anywhere between 50% to above 80% (a combination of senior and subordinated debt). Debt are raised either through borrowing from prime lenders (investment banks), institutions, or issuing of bonds. Interest payments are made from target firm and not from the private equity firm. Targets are typically firms with growth potential whose equity prices are temporarily depressed due to either market conditions or mis-management. Other characteristics of potential target includes: Low leverage: Why? Consistent cash flow history: Why? High level of tangible assets: Why? The buyout fund will typically make major management shifts. The objective is to: Turn the target firm around Raise the equity value of the firm Finally liquidate the firm, normally in a form of another IPO. Private equity and their buyout funds are notorious for. Self enrichment in the expense of or even to the detriment of target firms. How so? Buy, break up into parts, and sell the parts at more than the combine value. OR Buy, take huge debts, pay themselves, bankrupt the target firm. Obscene fees and bonuses they pay themselves. Do more damage than good to the target firm. Whether they earn better returns as an asset class (compared to say stocks) is debatable. Massive layoffs including top management. Lack of workers protection/benefits. Oct 2007: Texas Utilities (TXU) by KKR, TPG Capital, and Goldman Sachs for $45 billion. It is now known as Energy Future Holdings Corporation (biggest deal to date) The recent financial crisis has hit the private equity industry. The fuel that keeps LBO deals getting bigger and bigger is cheap

credit. During the peak of the crisis. Such cheap credit dried up. Shareholders rushed to sell. Buyers and their financers tried to back out. Many deals did not go through. The material adverse change clause. Average holding period has increased. Currently: Private equity firms are eager to exit. To prove their profitability. To attract more funds Mergers: combining two firms into one larger firm. Acquisitions: buying of a firm by another firm. What is the difference between the two? Distinction may be more psychological than legal one: letting the shareholder and employees feel better and easier to swallow Merger: Firms are normally of similar size with similar bargaining power. Voluntary: no such thing as a hostile merger. The owners co-owns the firms and the management cooperate to bring about the benefits. Usually ends with the dissolving of the two original names and creation of a new combined name. Acquisition - Usually involve a bigger and more powerful firm buying a smaller and less powerful one. May be friendly or hostile. The buyer owns the seller Types Horizontal: two firms in the same industry. Vertical: two firms in different levels of the production chain. Conglomerate: two firms in two different industries Trends: More cash deals. All-stocks deals are less common. More hostile bids. Percentage of buyouts increasing: more participation of private equity Premium is more realistic: once bitten twice shy lessons from bad and dubious deals in the 80s Buyers: Cost-saving synergy. Economies of scale: such as? Purchasing, Cost centers and duplicating departments can be merged: such as?? Human resource Accounting, IT Revenue synergy, Economies of scope, Vertical integration, Horizontal integration. Cross-selling: Example in banking? Universal banking: same customers can have savings account, insurance, buy structured products, etc Financial synergy - Reducing cost of capital, More bargaining power, Lower cost of debt and equity, Taxes: How? Buy firms with huge tax rebates to

reduce tax burdens, Diversification, Led to many conglomerate type of mergers. Example: GE Increase market share. The bigger is better argument. Dominance comes with advantage: examples? Market share begets market share: league tables Eat up competitors. Enter or break into other markets with high barriers of entry (even foreign market, protective market): example Colgate and Darkie toothpaste. To gain access to Technology, Patents, Intellectual properties, Processes, Distribution networks, Client base: brokerage, retail banking, credit cards, private banking Beware of agency problem - Empire building, Manager compensation if tied to revenue or profit, Free cashflow, nothing to do Sellers: Retirement, Estate planning, Expansion but capital market not desirable, Elimination of personal liability (for private company), personal guarantees on corporate debt, Divest business that does not fit into corporate strategy Alternatives to M&A: Joint ventures, Strategic alliance, Minority investment, Licensing, Technology sharing, Franchising, Market and distribution agreement

Role of Investment Banks in an M&A Higher premium for seller and lower premium for buyer. Management fee. Retainer: protect against flipflopping sellers. Importance of confidentiality agreement: Protect against misuse of information to the detriment of the seller. No disclosure of negotiation. Protection against revealing information to other prospective bidders. Chinese Wall: no sharing of information between department involved in the M&A deal with the trading arm Cash or stocks? Cash, stocks, cash and stocks. Advantage of cash transaction: Fastest and cleanest. Consideration of stocks transaction:?? Lower debt burden. Tax consideration: sellers not tax until sale of stocks Participation from seller. Dilution. Other consideration: information. Quality of earnings: low quality => more stocks to share the risk. Using of convertible debt: No immediate

dilution. Less dilution than offering common stock: why? Conversion price is normally set higher than present price Using of earnout or contingent payment: Getting more and more common: around 10% of all deals. Risk sharing between buyer and seller, especially when the business involves high intangibles: for example, tech firm, when a consensus on the valuation of the intangibles are very difficult to reach. Purchase price is split between payment at closing and one or more contingent payments within, typically 1 to 3 years. Payment is contingent upon reaching certain goals, i.e. realizing the value of the intangibles What are Takeover Defenses: Takeover defenses are employed when relevant party or parties in the target firm does not favor the deal. This could be because: Management entrenchment. The bid price is too low. Shareholders and management may clash over the takeover. Shareholders may want to sell but management does not want to. Shareholder does not want to sell but management wants to. In either case, a proxy fight may occur to oust the board/management Staggered board: how does it work and why? If only 1/3 (doesnt really need to be 1/3) of board is elected each year, how many years will it take to replace the whole board? Take longer for the acquirer to take total control of the board. The old board members can make things difficult for the new owner Supermajority: Require a high percentage of share to approve a takeover: typically 80% Fair price amendments: Floor price below which the offer is automatically rejected without even reaching the shareholder voting stage Poison pill: Strategy of making the stock of the firm unattractive to the acquirer. Flip-in: Allow the target shareholder to buy shares (normally by issuing rights) of the firm at a deeply discounted price, eg $0.01 . Trigger by event: a takeover bid (eg. when a bidder acquired 30% of the shares) or when a shareholder (controls 20% of the outstanding shares) Greatly dilute the share. The objective is to force the bidder to negotiate with the board

Flip-out or flip-over: Allow the target shareholder to purchase the shares of the acquirer at a deep discount after the merger. Normally by issuing rights. Once acquired, the rights will be flipped over Suicide pill or Jonestown defense - Extreme case of poison pill. Target firm take action that may destroy the firm. Example: take on huge debt, buy another extremely bad firm. Leverage recapitalization: Take huge debt to buy back share from shareholders or pay huge dividends. Share price will tumble Litigation: File law suit against bidder: fraud, antitrust, securities regulation, etc. Rather common: from 1960 to 1980, almost 1/3 of all takeovers. Antitrust: can amount to buying some other firms in the industry to increase the threat. Golden parachutes: huge severance payout to management. Crown jewel: sell the most important asset Pac-man - Target buy the acquirer. Usual gets very messy and everybody loses. Example: Bendix tried to buy Martin Marietta, Martin Marietta tried to buy Bendix back, United Tech help Martin Marietta, Bendix saved by Allied Corp (White Knight), Martin Marietta ended with high debt and partially owned by Allied Corp, Now Allied Corp is called Honeywell Justification of defense: Why defend? Management and/or shareholder does not believe that the acquirer will act in the best interest of the firm after taking over Hope of getting a better price Stalling tactic to wait for a White Knight Stalling for the firm to emerge from trough Most defense tactics are valuing destroying Cannot be for sentimental reasons Integration Crucial after M&A - The sooner the firm goes into the business-as-usual mode the better. A team staffed by senior management may be put in charge of the integration. Many M&A fail because of poor integration even if the economic rationale is satisfied. Anti-trust issues. Shed off some of the units Incompatibility issues: Technology: Computer system: protocol, Machinery, Parts compatibility

Corporate culture Easy/cosy vs bureaucratic/formal, Open vs close, Trust/cooperative vs competitive Human resources: Dissentment of acquired (or acquiring) employees Competitors may try to poach star or key employees Employees benefits: health care, insurance, pension Retrenchment benefits New management may not understand the culture of the target (or acquiring) firm Reshuffling of key personnel Cooperation between management and key personnel of both firms More problems if employees are represented by unions Redundancy: Inability to merge system Inability or unwillingness to retrench staff Overcutting: Cut away too important system or staff Problems multiplied Regulatory burden