Peanuts, monkeys and why the idea of investing for the longer term is a no brainer

As part of my multi-disciplinary Master’s degree, I did one unit in the Business School about business strategy. There I sat in a lecture room full of keen-eyed, shiny business students and me, the curious arts student whose entire career has been in the private sector, a large chunk working in investment.

As with many clichés that were trotted out during that course, the one that just made my heart sink due to its sheer lack of critical thinking, was the old chestnut “if you pay peanuts, you get monkeys”. I countered that actually, sometimes if your incentive packages have large sums of money tied to short-term performance at its centre, you create the perfect environment for monkeying around. Sub-prime mortgages and the GFC anyone?

So imagine my reaction when I read last month that some of the gorillas of the investment world were holding secret summit meetings to “encourage longer-term investment and reduce friction with shareholders”. The Financial Times’ supplement FTfm reported that meetings were held with Warren Buffet, the chief executive of JPMorgan Chase Jamie Dimon and the heads of heavyweight investment houses Fidelity, Vanguard, BlackRock and Capital Group.

The investment industry were obviously concerned that they were not aligned with the requirements of listed companies looking to grow their business; or their actual end-customers, you and me, who invest for long-term wealth development. At the top of the companies’ complaint list was the institutional shareholders focus on short-term returns, compared to long-term growth goals of companies.

The problem is that the investment industry markets its short-term performance to get more of the real capital owners, you and me, in the door and boost their funds under management. It then also creates incentives for its investment staff based on their short-term performance. They are not all like that, the best active fund managers do take long-term views and engage with companies and their trading volumes tend to be less. But many others churn through trades in passive or shadow-passive funds just trying to replicate an index to make their performance targets, which are very often tied to their performance versus the index. It would be more useful for the investment industry to tie incentives to longer term performance, in line with us, the customers, many of whom are saving over the long-term for retirement.

The Association of Superannuation Funds of Australia estimates there is $AUD2 trillion invested in superannuation, of which $AU317 billion is invested in Australian equities with a further $AU183 in Australian fixed interest. Australia is the fourth largest superannuation market in the world, behind the United States, Japan and the United Kingdom.

The United States had an estimated $US23.5 trillion in retirement savings as at 30 September 2015, according to the Investment Company Institute inside a variety of retirement savings vehicles. This does not include other investment savings, just the money in vehicles designed for long-term investing. According to Goldman Sachs, 69% of the US stock market is owned by US households, mutual funds and government and pension funds. The remaining 31% is made up of predominantly international investors (16%) with the much-talked-about hedge funds holding only 4%.

The British Investment Association stated that 38% of the £5.5 trillion of funds under management are British pension funds in 2013. According to Towers Watson, the Japanese pensions funds had $US2.8 trillion under management.

That is a lot of people looking for long-term investments to give them financial security at retirement. Surely the stewards of their money should align their activities with their end-customers.

The sleight of hand that separates the owners of money and those who manage it

An article I wrote with Christine Daymon has been published in the Journal of Public Relations Research.

http://www.tandfonline.com/eprint/MRx7cwJEyA4WU8a7WwRz/full

Our study investigates how the definition of ‘shareholders’ are constructed and engaged with through public relations in the Australian financial sector. We found that there is a hierarchy within the stakeholder group known as shareholders which is perpetuated by and through a public relations approach which constructs a discourse of ‘ownership’ that excludes citizens as legitimate stakeholders and prevents their influence in ensuring a more responsible sector.

In responding to the challenges of greater public scrutiny many companies have focused on developing communication strategies that espouse a commitment, through policy and practice, to involving stakeholders in a positive manner in organisation activities. At the core of such strategies is the notion of stakeholder engagement which, ideally, involves processes of consultation, dialogue and exchange with the intention of enabling cooperation and increasing understanding and allows stakeholders such as shareholders, consumers, and employees to exert an influence on corporate governance. In practice, and from economic and legal perspectives, the foremost accountability relationship of managers is deemed to be with shareholders. This relationship is supported by conventional stakeholder thinking whereby shareholders are considered to be a core stakeholder group with a formal claim on a company because their support is necessary for that company to exist. The nature of the relationship between an organization’s management and its shareholders has been explained through agency theory. Shareholders, as the principals or owners of companies, are the primary constituents who delegate their decision-making rights to an agent. Whether or not one agrees with the view that the economic obligation of business supersedes its social obligation, there is a problem with agency theory in that it relies on a definition of the shareholder as one who makes a direct investment in a company (such as an institutional fund, or someone who buys shares through a stockbroker). That notion has become less applicable, and even out-dated, in the modern economy. In capitalist economies today, a substantial portion of the capital that fuels the daily activities and growth of major national and international listed companies is provided by indirect investors (i.e. citizen investors) through pooled or institutional funds, such as superannuation and pension funds, which invest and manage monies on behalf of others. For example, in Australia in 2010, the nation’s central bank, the Reserve Bank of Australia estimated that around 40 per cent of the country’s equity market and 30 per cent of the bond market were owned by Australian-based institutional shareholders, predominantly superannuation funds.

The insertion of an intermediary (i.e. an institutional fund) between the real owners of capital (citizen investors) and the management of the listed companies in which they invest presents a complication for the traditional investment relationship which previously was based on a delegation of responsibility from direct shareholders to management.

The consequences of the discrimination that is perpetuated through public relations’ engagement strategies are that citizen investors are not educated about their role and rights as legitimate shareholders. Nor are they informed of the possibility to influence ethical, corporate decision-making and hold companies accountable for unacceptable actions. This is paradoxical when the same citizens who are passive as shareholders simultaneously may be engaging in public protest against the activities of the very same companies in which they hold investments. We have argued that if the engagement strategies of the Australian financial sector were equitable and responsible, then citizen investors might be motivated to actively contribute to corporate decision-making. The need then for public protest against corporate recklessness might be mitigated somewhat.

Engagement has a moral dimension and suggest that our application of the concept of engagement has been enriched by including consideration of responsibility and irresponsibility and public relations practitioners can contribute to a shift in how citizen investors and the broader community understand the meanings of ‘shareholder’ and ‘ownership’ with their subsequent rights and responsibilities, and potential for influence.

Tax avoidance is rewarded by the financial markets

This weekend the leaders of the G20 nations met in Brisbane and corporate tax avoidance, or ‘minimisation’ was on the agenda. There has been outrage in recent months as it was revealed that large companies have routed money through complex structures in countries such as Luxembourg in order to minimise the tax. The objective is to maximise profits for shareholders and minimise a company’s contribution to the community benefits derived from tax payments.

Some of the companies are global household names such as Ikea, Pepsi, Deutsche Bank and use these methods. Apple and Amazon have been at centre of similar controversies in the recent past. While many commentators are focused on the impact on the public purse of those countries where revenue is generated, very few are asking why the dominant value of profit maximisation is allowed to continue to reign. It is just assumed that is what companies will do and markets will accept it.

Why is profit maximisation more important than paying reasonable tax to help develop the countries from which corporations derive their revenue? Why does short-term earnings results designed for the investment markets get more senior management attention than long-term investment in the future of societies for hospitals and health care, schools, roads, public transport and the like? This community investment through tax payments also benefits the very same companies which use the infrastructure networks such as roads, rail, airlines and ports, and whose employees and their families go to the schools and use the hospitals.

It is because those in senior management at these companies and those that control the investment decisions at large institutional investment groups, prioritise a very narrow set of short-term profit-driven values over the longer term goals of a rise in living standards for all. We know that they share the same values because investment funds participate in the same tax minimisation schemes. Public investment funds from Canada, Australia, as well as investment giants like Citigroup, Credit Suisse, ABN Amro, AIG, Dexia, Fidelity, Schroders, State Street and UBS were also on the list of tax offenders released by the International Consortium of Investigative Journalists.

These investment houses manage billions of dollars of citizen’s retirement and other savings through a variety of mutual funds. And because they have the power to make the investment decision, they impose a narrow set of profit-driven values on their decision. They do very little to gather the views of the citizen investors or reflect them in the investment decisions.

As those who provide the money for these funds to invest, we have a responsibility to make it clear that we are not only the ultimate shareholders of these funds who want a long-term return from our savings but we are also the people who use the infrastructure, the schools and the hospitals that improve our societies’ standards of living, as opposed to wanting our investments to produce a short-term return to boost the bonus payments of our professional money managers.

A virtuous approach to investing could benefit us all

Laura D’Olimpio argued in her recent article on The Conversation, that the ancient Greek philosopher Aristotle claimed that being virtuous was rational and good for everyone. Humans, he wrote, are political and moral creatures because we live in a society and our behaviour affects one another. Virtue is the mid-point between excessive or deficient behaviours and finding the mid-point was crucial for everyone to flourish. For instance, we may have to pay $5 more for a T-shirt, and a large Western organisation may need to take a small cut to its profit margin in order for garment workers in Bangladesh to have a safe working environment and enough money to support the family. But everyone still wins because we still get cheap t-shirts, the business still makes money and people in Bangladesh improve their quality of life through economic growth.

But the spectre of renowned free marketeer economist Milton Friedman still looms over the financial markets and listed companies. Friedman believed in the view that the only social responsibility of business was to make profits’ is still a dominant belief among large investment houses and the companies they invest in. Therefore, maximising profits is a seen as a virtue in this world.

Indeed, Max Weber, as cited in Dyck and Schroeder’s 2005* article, wrote that materialism and individualism are the twin hallmarks of the moral point of view that underpins management thought. A focus on work and emphasis on material success has become normalised in western management and is the ‘uncontestable, objective, morally neutral ‘reality’’ adopted as the natural facts of life, rather than a particular version of the ‘moral’ facts of life. This translates into modern management’s focus on efficiency, productivity, profitability, measured by performance relative to other comparable companies and the expectations of the market.

Materialism is used as a tool to measure human progress, a method of attaining ‘success’ and social acceptance. In 2010, Decktop, Jurkiewicz and Giacalone** argued that financial success and material possessions are the core elements of western corporate cultures and financial rewards at work are used as a form of motivation and control. Materialistic values are rewarded in employees because they are aligned to those in senior management. In this view, money and the desire for money equal competence and the acquisition of more of it (particularly more than someone else) equals greater competence. People with these values gravitate to jobs that can be measured by material accumulation. In corporate finance books this belief is reinforced. According to the Principles of Corporate Finance, ‘the goal of maximising shareholder value is widely accepted in both theory and practice’ because, the authors argued that shareholders’ priority is ‘to be as rich as possible’ (Brealey, Myers and Allen 2011). The question of ‘why is this important?’ is not considered.

Companies are held captive by the tyranny of a quarterly earnings reporting cycle that focuses on short-term profit making rather than long-term sustainable business development. This benefits the privileged class of institutional investors who make their money by managing trillions of dollars of other citizens’ money. They market their competence as investors to attract more money, based on these short-term returns. When the reality is most of their investors have a very long-term investment timeframe and quarterly results are not particularly relevant.

This mismatch in expectations between the average citizen whose retirement funds are managed by institutional investors, and the investors and senior managements of companies themselves is demonstrated in the recent research by Harvard Business School and Chulalongkorn University. The research showed that the average citizen around the world believes that CEOs earn far more than what is a fair amount, when compared to an unskilled workers. What was worse is that the estimate was completely out of kilter with the astronomical pay packets that actually get paid, which is supported by most fund managers.

Surely this is an example of one group, the powerful elite who manage and influence the management of large listed companies, who’s values are at the extreme end of a spectrum, and the virtuous mid-point which allows everyone to flourish is a long way, away.

*Dyck, B. and D. Schroeder. 2005. “Management, theology and moral points of view: Towards an alternative to the conventional materialist-individualist ideal type management.” Journal of Management Studies 42(4): 705-735.

** Decktop, J., C. Jurkiewicz, and R Giacalone. 2010. “Effects of materialism on work-related personal wellbeing.” Human Relations 63(7): 1007-1030.

The house of cards versus building economies – the shift to trading from investing

I recently finished reading What Happened to Goldman Sachs: An Insider’s story of organisational drift and its unintended consequences, Steven Mandis’s study of how the priorities of one of Wall Street’s most respected investment banks changed from providing trusted advice about long-term growth of businesses to short-term profit production for its employees and shareholders.

As a former Sachs employee, Mandis was curious about how the Goldman Sachs he joined in the 1990s, which was renowned for its customer-centric ethics and social code, turned into the one of the morally questionable actors of the global financial crisis. It tracks the drift in values since the 1970s and covers a period of rapid growth for the company and the financial services industry.

Mandis noted (pg 98) that the rapid growth in Goldman’s business meant thousands small decisions, made quickly and by many, accumulated into a significant tidal wave of change, and everyone was too busy to notice. Changes included the rise of a culture of undisciplined risk taking driven by the rising prominence of profit-making trading over advice and the dilution in the strength of its cultural norms as the business expanded quickly around the world.

More importantly it highlights the shift from banking to trading (pg 143) and how, as trading produced greater profits for the bank (rather than the clients), the culture shifted from ‘value-added vision and tilt more to making money first’ and asked the question ‘if making money is your vision, to what lengths will you not go?’.

Mandis examined what pressures existed to meet organizational goals generally caused by ‘unintended and unnoticed slow process of change in practices and the implementation of them, which in those cases led to major failures.’ This can be expanded out to the whole investment industry which, when inundated with the retirement savings of ordinary citizens into their mutual funds, suddenly had more sway with the companies than ever before.

Fund managers, wielding the investment power of the accumulation of many citizens’ funds, held more sway with company management. The power for decision-making, and the shaping of global business, resides with a small group of senior managers who make decisions with reference only to a small group of professional investors, i.e. decisions are made by those who manage the money, rather than those who provide and ultimately own the money. It is the beliefs and values of the professional investors that are represented, not those whose capital offers the companies the opportunity to continue business and the superannuation funds a chance to have a business.

Indeed, it is telling when the chief executive of the world’s largest miner BHP Billiton describes spinning off a basket of its lesser performing assets into another company as a way of ‘financial markets’ being happy. No mention is made of the values and views of the citizens’ that provide the capital to the financial markets.

It is also interesting to note that an independent senator in Australia’s parliament, Nick Xenophon, chooses to focus on the decision of the nation’s flag carrier Qantas to only consult with its largest institutional investors about controversial management decisions, rather than include the large number of smaller shareholders. He would perhaps, have been well served to question why the big institutional shareholders made no effort to listen to the views of the thousands of citizens who provide the capital to invest in Qantas. These are the citizens who may also work for Qantas, or are a supplier or contractor to the airline, or even are a frequent flyer.

It is time that large asset management houses created genuine engagement programs with their members to discovery what their investment values really are, in the context of the whole society, not just how much money they want to retire on, and base some of their decisions on that ethical compass, rather than the one that points only to the god of Mammon.

Expanding how we ‘profit’ from oil and gas extraction

Western Australian Premier Colin Barnett sent a shot across the bow of the oil and gas companies that operate off the Western Australian coast at a recent industry conference in Perth by challenging their notion of social licence.

Financial journalists and politicians looking for a hook to hang him on immediately started to quibble about some of the factual detail around ownership of leases and completely missed the opportunity to debate the broader point, on which Mr Barnett was right. That is, companies do need to seriously look beyond their own bottom line at how they treat the Governments and communities in which they operate and provide more of a legacy than local libraries and playgrounds.

The fraught issue of who profits from oil and gas extraction and how they profit must be seen from a multilayered perspective and how we see it is clouded by an increasingly outdated notion of stakeholder theory.

Stakeholder theory is the basis of how many businesses engage with various ‘stakeholders’ and their interests. For example, groups get divided into ‘shareholders’, ‘customers’, ‘government’, ‘activist groups’ and ‘local community’. Then they are usually separated and ranked according the importance to the senior management. For large listed entities, the very top of the tree is usually shareholders (to which I mean large institutional investment groups who manage money on behalf of others), and meeting the demands of this prioritized group(s) can be the greatest influence on decision-making.

What stakeholder theory overlooks is that most stakeholders belong to more than one group, who may ‘profit’ or lose in more than one way, and who the stakeholder really is may be obscured at first glance. For example, oil and gas resources in Australia, including coal seam gas, are owned by the relevant State or Territory government or Federal Government (depending on whether it is onshore or offshore) on behalf of their citizens. The relevant government then grants licences to companies to explore and extract these resources and ‘profit’ on behalf of their citizens through the collection of royalties.

So the owners of the assets are the citizens of the relevant State, Territory of Australia or Australia itself and they profit through: the collection of royalties; the access to the resource they own (domestic gas supply); and community economic development through job creation. This same group may also ‘lose’ if the extraction of resources unnecessarily damages their environment or the opportunity cost of losing other industries, such as agriculture, fishing or tourism is seen as too great.

While the oil and gas extraction companies will say their fiduciary duty to place shareholders first, they may not recognise that the capital provided to institutional shareholders to whom the oil and gas companies are trying to deliver a profit are some of the very same citizens who own the resources they extract. The capital flow comes through savings such as superannuation funds and other retirement savings.

For example, the coal seam gas enterprise Arrow Energy is a joint venture owned by Royal Dutch Shell plc and PetroChina Company Ltd. As a 14 February this year, Shell stated in its 2013 Annual Report that major investment houses such as Blackrock and The Capital Group owned more than 6% and 3% respectively. In turn, Blackrock on its website states in runs $US4.3 trillion in investments around the globe on behalf of ‘governments, companies, foundations, and millions of individuals saving for retirement, their children’s’ educations and a better life’, including Australian citizens. In this scenario the citizens ‘profit’ through the increase in share price and payment of dividends.

The offshore oil and gas activities in the north west of Western Australia are dominated by majors such as Shell, Chevron and Woodside all of whom are large listed companies with institutional shareholders, who would manage the millions of dollars of individual savers. These are the companies at which Mr Barnett was taking aim, particularly after the decision to develop an offshore floating processing plant, rather than base it onshore in Western Australia and create opportunity for the local communities.

Oil and gas companies need to consider how to balance all of these streams of ‘profit’ more evenly and consider opinions beyond the institutional shareholders who manage citizens’ money, often without reference to their views. They may also need to learn to find value in the competing view that their citizen stakeholders’ don’t necessarily wish to ‘profit’ from the extraction of resources but would rather use the land and sea for other means, such as agriculture, or even to leave the environment untouched.

The fruit of SPC Ardmona’s labour should not be closure

And so it has come to this. The Liberal government has washed its hands of supporting the last fruit and vegetable processor in Australia as part of its ‘age of responsibility’. But let’s be honest, this is more about their ideological stance about unions and a chance to make their point while attacking some of the lowest earners in Australia for having generous working conditions. I look forward to their attack on investment bankers…

Coca-Cola Amatil now has a decision to make about the future of SPC Ardmona, and the final decision will need to be seen as ‘investor friendly’. To its credit, unlike the car manufacturers, the company’s plan was to completely re-tool the plant to make it profitable into the future, with some federal government support. The question now is can they gain the support of institutional investors to make the entire investment themselves?

SPC Ardmona is a major employer in a region that has an unemployment rate that has been at least two per cent higher than the Australian average for at least four years.

The preservation of local food production is a personal passion of mine, not just in Australia but around the world. We have to eat every day and how we eat and what we eat really matters. Beyond that, the case of SPC Ardmona is a litmus test of the dominant values in our society. Is finding a way to preserve the Shepparton community and make money from our fabulous fruit and vegetables in the long term, more important than propping up the short-term market returns of a listed entity?

It is evident that the processor needs support to weather the perfect storm of circumstances in which it has found itself during the past few years, but it also needs a long-term sustainable business plan. Much time and energy is spent on the CC Amatil Sustainability Report, which also includes a section on workplace commitment. Perhaps the company could consider that making this investment would fit into that workplace commitment and create a real legacy which would have positive repercussions for generations.

According to its 2012 annual report, the Coca-Cola Company owned 29% of CC Amatil as at 31 December 2012, followed by a range of institutional investors.  All of these groups need to consider their role in this situation. Of course, it is hard to know who these institutional investors are because most of them use nominee companies, thus obscuring their investment from public view. But at 31 December 2012 the investors in HSBC Custody Nominees (17.65%), JP Morgan Nominees (13.32%) and National Nominees (9.69%), would all have significant influence over the board. The board and the investors need to understand that corporate social responsibility is more than ‘nice-to-have’ reputational insurance. Taking a financial hit now to save SPC Ardmona, and the community it supports, will make CC Amatil a leader of business reinvigoration and a true corporate citizen. It may even make it some money.

Well done Aldi for committing to use only SPC Ardmona for its 825g fruit product in Australia.