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.

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.