Mind the values gap on the CEO pay issue

Nothing ignites the anger and disgust of average employees and citizens upon discovering that the pay packet of a CEO is vastly inflated compared to the value they are perceived to add to a business. It is even worse if a business has performed poorly and a leader is pushed out the door with a ‘golden goodbye’ windfall payment.

The issue of CEOs’ pay is very often the first example used to demonstrate how out of touch the ‘elite’ classes are with the values of the average person. And studies show that big pay packets don’t necessary equal big performance. Why, we ask, do they need so much more money? Why do they think they deserve it? Why is the job worth that much compared to the average wage?

At the heart of the problem is a fundamental difference in what each party in the debate values.

For CEOs and the institutional investment community, the purchasing power of a salary package and whether it reflects the value of the job being done is irrelevant. A salary package is now about comparative value to peers and not about the dollar amount. And earning more than someone else, means more status and a place higher up the elite social totem pole.

The earners in this stratosphere are so far beyond worrying about providing the basics of life for that to be irrelevant to what has meaning in their lives. If you applied the notion of valuing these roles by the job being done, it would be hard to argue that a CEO of a global company in a particular field is exponentially more valuable than, for example, leaders of governments or a global humanitarian institution. But they are paid exponentially more. Money is the measure of status and social worth in that small, select group. Everyone else can eat cake.

When discussions about average or minimum wage earners are discussed, however, the debate focuses on ‘what is the job worth’ and ‘what can the business afford’, which is an entirely different value measure. People in this arena are worried about the ordinary issues of life like paying the rent or a mortgage, funding their children’s education, making sure they can afford healthcare. Businesses paying employees are worried about containing costs, meeting budgets and making a profit. Social status is secondary in the conversation.

And this is the point at which the disconnection occurs between CEOs, the institutional investors that support them and the rest of the world. The self-generated rhetoric that ‘we are worth it’ continues to widen the values gap as  the general public watches as KPIs are not being meet and company value is destroyed.

It is heartening that institutional investors are starting to question CEO pay packets and reject more outrageous ones but a broader conversation needs to be had about what is a reasonable salary. These CEOs are answerable to their shareholders. The institutional investors may be the named shareholders but they are the intermediary managers of capital owned by you and me, through our retirement savings, regular investments and through sovereign funds held by government in our name.

The values of both the CEOs, the boards and the institutional investors need to be more closely aligned with the values of the real owners of capital, who live back here on the ground, and not in the stratosphere of social entitlement.

Market response to Brexit demonstrates why cheap passive funds aren’t good value for the economy

The volatility and volume of trading in the global market response to the surprise result of the Brexit vote on Friday is an excellent example of why cheap passive funds are not good value for the economy, or the markets.

The crashing market, provoked by the panic of what the vote result might mean, was exacerbated by passive funds scrabbling to meet their investment mandate, which is to replicate particular indices.

Passive investment managers aim to create a portfolio of stocks that replicates the performance of a nominated index, such as the S&P/ASX 200, the FTSE 100 or the S&P 500. Their investment decisions and trading activity only reflect changes to the index, not a considered investment decision by an investment professional. There is no consideration of what each company is doing and the economic value they are creating for shareholders, rather the trading is focused on responding to what other investors are doing.

This trend also reflects the rise of the importance of trading over investing. The desire for the quick return, matched with the short-term quarterly reporting culture rewards the buying and selling of assets rather than investing in companies that will produce longer-term growth.

The funds merely replicate an index, which is just a collection of companies that are acknowledged by size, rather than quality. And trading in and out of them is based on a logarithm that is adjusts to continually reflect the market, which moves based on other people’s decision making. It is not based on an assessment of the future growth of the company, the quality of the management and the value the company adds to the economy.

The rise of the passive fund management industry reflects the belief of quantitative analysis as a ‘cost-effective’ way to invest and not have your returns eaten away by asset management fees.

Indeed one of the great active management houses, Fidelity Investments, has decided to start offering passive funds on third party platforms in response to customer demand.

The Financial Times reported recently that passive funds have risen to have $US6bn, up 230 per cent since 2007 and growing at four times the rate of active fund management, according to Morningstar. The focus of passive investing is on the cost of the investment, rather than the value of the investment. Indeed, the marketing of passive funds has focused on the cheapest of the option to invest in a market, because over the long-term equity markets rise.

Active investors haven’t helped themselves with eye-watering fee structures for often ordinary performance. The ‘long-only’ funds, which are allegedly designed for fund managers to buy and hold equities they believe will grow over the long term, have vast pockets of mediocre performance, sometimes due to mediocre managers, sometimes risk parameters that make it nigh on impossible to produce a decent return and sometimes because the fee structure rewards average performance and robs the end investor.

Hedge fund managers, who market themselves as superior to long-only traders because they also bet against stocks they think will fall, leech about half of pre- fee returns  but very often produce mediocre returns as well.

Passive funds do not participate in corporate governance discussions, they do not add to the public debate about company decisions nor do they invest on the basis of good company management decision making. They may be cheap, but they add no value. Indeed, as the events of the past few days have shown they add to the problem.

Active managers need to be less greedy and prove how they can add the value that company management so desperately needs.

Milking the dairy industry dry leaves us all poorer

Once upon a time, two large milk wholesaling companies faced public backlash about their decision to unexpectedly pay dairy farmers less for milk than it cost to produce and apply it retrospectively.

The good consumers of Australia, frothing with outrage, supported the local farmers by buying the named brands milks at the local supermarkets and took photos of the sold out sections of milk fridges and plastered them all over social media. The supermarket brand milk remained on the shelves and the consumers conveniently ignored the fact they had propped up this unsustainable system by buying $1 a litre milk for the preceding two years.

Meanwhile, in a spectacular display of cynical cause-related marketing, Coles, one of the originators of the $1 a litre milk in 2011, launched a special brand of milk that was more expensive with 20c from every sale going to a fund for the farmers.

This is the same supermarket chain that signed a 10-year milk supply deal with Murray Goulbourn, that according to their public statements at the time it would be ‘a major win for farmers because we cut out the middle man and farmers get a bigger share of the retail price’. Three years in, that doesn’t appear to be working.

The real bottom line in this ethical conundrum that we all need to consider, how much do we value our dairy industry? How important is it for Australian to be able to produce its own milk and dairy products and, if that is important, what is a viable price to pay the farmers who make it?

For the investment managers investing in Woolworths and Wesfarmers (the owner of Coles), an important question is when the stand over tactics of the supermarkets’ on their suppliers actually starts destroying the economic value of an entire industry, is it time to look more broadly than just what creates profit margin for the two powerful distributors?

Beyond the marketing, the real story is, in 2011 the supermarkets, started offering $1 a litre milk, purportedly to make milk ‘affordable’ for more people, even though it has been bought by the majority as a valued staple food for decades. Cheap milk was the enticement to get customers in the door and then get them spend up on other higher margin products. It was part of a vicious price war between the two major supermarket chains in an attempt to defend and grow their market share.

It was never going to be the supermarkets that bore the brunt of the price cut, they can choke the distribution channels, so held the power to pass financial pain onto their suppliers. And the institutional investors who bought shares in Woolworths and Wesfarmers (the owners of Coles) approved of this margin clawback because it delivered on the profit line.

And the customers bought the $1 milk, telling themselves that is what they could afford. Until now.

This week’s debate about the value of the Australian dairy industry, what is reasonable for the farmers to earn and what we are prepared to pay for milk the perfect parable to demonstrate the cause and effect of valuing the profitability of the dominant and powerful groups in a production chain, over the value of the product and industry itself to a society.

Murray Goulbourn and Fonterra are not blameless either. MG were briefing shareholders this month that there was no concern with their financial stability, with a strong balance sheet and a growing business, but in the same breath talking about a Support Package for farmers to spread the impact of the cost cuts over the next three years. So, they won’t absorb any of the price pain, but are happy to pummel the farmers, without whom, they wouldn’t have a product to sell.

We, as members of superannuation funds and other investment vehicles, provide the capital to the likes of Woolworths, Coles and Murray Goulbourn and we can use our collective power to be more thoughtful about the impact of their profit seeking on entire industries. Pushing the pain down to the most powerless group in a supply chain makes us all poorer.

Questioning our values more use than a banking royal commission

The criticism of the behaviour of Australia’s financial services industry hit fever pitch in the past weeks with the Federal Opposition calling for a royal commission  into the sector and even the Prime Minister Malcolm Turnbull criticising the big four banks for damaging public trust.

A royal commission might give us all a chance to be outraged at the banks’ naughty behaviour but it would not reveal anything we didn’t already know, nor is it likely to examine the underlying societal value that is the root of the problematic culture.

Two recent forays by financial service regulators into considering the impact of culture on recurrent problems failed to do it, so why would a royal commission be different? That is, a dominant value demonstrated in Western capitalist cultures is the belief that, profit in business has value above all things. And maximizing the profit of a business is more important than the interests of any other stakeholders, including its customers. It is essentially alright to milk your customers for outrageous fees, unsuitable investment products and insurance products that are impossible to claim on, if you are adding to the bottom line for another ‘record profit year’ to report to the market.

Earlier this month, the banking regulator the Australian Prudential Regulatory Authority (APRA) warned that it had some concerns about the level of household debt in Australia and the Australian banks’ exposure to the mortgage market.  ABC’s 730 Report showed a revealing piece of footage of APRA chairman Wayne Byers testifying at last year’s Senate Estimates Committee that the regulator was “a bit surprised by how much the competitive pressures in the industry and the competitive dynamic in the industry had led people to do things that were, you know, really, in our view, lacking in common sense.”

The issue of lending money to secure market share, beyond a point that is a suitable risk for the lender and the borrower, is directly linked to the value of making a sales target to bolster the company’s profits. In a running bull market, the banks allowed their retail mortgage divisions to be focused on market share, and remuneration packages for sales employees will be geared to sales targets. Time and again, insufficient risk assessment of what that exposure is doing to the whole business is ignored or downplayed and the customers are allowed to borrow their way into a disaster.

Meanwhile, the funds management regulator, the Australian Securities and Investments Commission (ASIC) was also pondering the role of culture in driving conduct and conflicts of interests in fund management companies that both create and manage funds and sell them through financial advisory arms that they own. In ASIC’s Report 474: Culture, conduct, conflicts of interest in vertically integrated businesses in the fund management industry, released this March, ASIC pointed out that where a financial services company manufactured an investment product and owned the distribution chain through financial advisory services, there was a strong chance that sales representatives were pressured to sell the ‘own brand’ products, whether they were the most suitable for the customer or not. This feathers the nests of the sales representatives through salary incentives aligned with the organisation’s own profit maximisation strategy. The needs of the people paying for the service, the customers, are secondary. This is a mis-selling scandal waiting to happen.

By failing to consider the values that underpin our culture, we condemn ourselves to making the same mistakes over and over again. These mistakes erode our faith in the financial services sector that is crucial to a healthy economy.

Making a profit is a cornerstone of a healthy business sector, but endlessly pursuing record profits is a short road to poor ethical choices because it turns the focus away from the customers’ requirements and prioritizing a business’s own desires. Rather than just driving up the share prices of companies that make bumper profits, perhaps we should spend more time considering how the profits are made and punish the share price of companies that put their own interests above all others to get their pot of gold.

The Panama Papers reveal the ugliest parts of a bigger transparency problem

The fascinating phrase ‘ultimate beneficial owner’ kept popping up in the coverage after the release of the so-called ‘Panama Papers’ this week. It referred to the masking of the true owners of assets under layers and layers of shell companies and nominee directors.

Tax agencies, legal authorities and fraud investigators have all decried how the web of shell companies camouflaged the ‘ultimate beneficial owners’ making it extremely difficult for these owners to be held accountable for how the assets were acquired, to pay the appropriate tax in the jurisdiction in which their money was earned or to understand their level of influence in the halls of power.

In the outrage at these unidentifiable ‘ultimate beneficial owners’ and the lawyers who help them to set up the structures , the importance of transparency of knowing who owns what, and who has influence was raised again and again.

But before we all get swept up in the outrage of it all, it is worth reflecting that the lack of transparency regarding ‘ultimate beneficial owners’ of any large company is rife throughout the financial system, so much so that it can be argued that it is accepted as the norm.

For example, as part of their commitment to transparency of ownership, Australia’s biggest companies list their top shareholders in their annual reports but a quick flick through these lists shows the laughable nature of this proposition. Most of the names on the list are nominee companies. The biggest ones are HSBC Custody Nominees (Australia) Ltd, JP Morgan Nominees Australia Ltd and National Nominees Ltd.

Australia is not alone; the nominee company system is widespread in the Western financial services sector. Nominee companies are custodian services that allow investments from a number of investors to be aggregated into one entity. According to the Australian Securities and Investments Commission (ASIC) they typically hold securities, arrange the banking of dividends and some form of consolidated reporting. They don’t engage with senior management or boards about how companies are run on behalf of their clients.

In fact, in submissions to a 2008 parliamentary committee inquiry on corporate governance, large listed companies raised the use of nominee companies as a key barrier to the effective engagement with its shareholders. The companies said the use of nominee entities also made finding the ultimate owners of shares difficult. This makes it very hard to align the long-term investment goals of superannuation funds and the short-term remuneration and performance goals of senior management and professional investors.

It makes it easier, however, for those investing to lose the connection between how and where their money is invested and the impact that has on the values reflected in our society.

If it is fair and reasonable that people hiding money in offshore companies should come clean about how they earned it, why they should minimise their tax to avoid funding the infrastructure of a civil society such as education, health and transport systems and what influence they wield, then it is also fair and reasonable that those of us who have a retirement fund know where that money is invested and its ultimate use.

The fund management industry’s use of nominee companies makes this incredibly difficult.

Creating barriers between ownership from investing helps us to disassociate ‘making a return on our investment’ from ‘how we are making a return on our investment’ and the impact that has on the values and culture underpinning our society.

Surely greater transparency across the whole of the financial system, not just the ugly, dark corners will benefit us as a society.

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.

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.