Monday
Jul112011

Corporate Social Responsibility and the Alien Tort Statute: Supreme Court Bound

Corporate social responsibility is a much discussed topic within the world of corporate governance.  With companies having to profit maximize, the argument for engaging in socially beneficial behavior is often a hard one to make.  To the extent that socially responsible behavior results in profit maximization (doing more to avert global warming might increase the number of customers who buy the company's products), management has an incentive to engage in the behavior.  But many who give serious thought to the area view profit maximization as too cramped a basis for encouraging corporate social responsibility.

There is one law, however, that potentially encourages corporate social responsibility, whether or not consonant with profit maximization.  The Alien Tort Statute allows suits to be brought in US courts for violations "of the law of nations or a treaty of the United States.” 28 U.S.C. § 1350.  The statute has sometimes been used against US companies for allegedly aiding and abetting human rights violations by foreign governments.

The right to bring these cases against corporations has been controversial.  In general, the cases do not involve actual human rights violations by the corporations.  Instead, the arguments are usually that the corporation somehow supported or promoted the violations through various forms of assistance.  While courts have accepted that claims for aiding and abetting can be brought under the ATS, they have generally been restrictive on the types of behavior that might qualify under this standard.  Nonetheless, there has been some legal tension in this area. 

Last year, however, the Second Circuit rendered an extraordinary decision.  It held that there was no support under international law for bringing actions against corporations.  See Kiobel v. Royal Dutch Petroleum Co., 621 F.3d 111 (2d Cir. 2010).  As a result, corporations, even if they engaged in direct violations of human rights, could not be sued under the ATS. 

Well, it turns out that not all courts agree with that position.  In John Doe v. Exxon Mobil Corp., 09-7125, July 8, 2011, the DC Circuit, in a 2-1 decision, held that corporations could in fact be sued.  There is always a possibility that the decision will be reversed by the court en banc.  But if that does not occur, the Supreme Court will likely take the case.  It is a serious split among the circuits.  Moreover, the dissent was written by Judge Kavanaugh, who's views are taken seriously by the conservative majority.  Finally, it is another opportunity, much like Morrison, for the conservative majority to potentially cut back on the use of US courts by foreign nationals, despite the existence of a statute that expressly provides the authority.  

Thursday
Jun172010

BP, the Dividend and the Board (Part 3)

With all of that background, where does it leave the dividend issue? 

It is unequestionably a political problem.  Clearly, the nonpayment of the dividend will annoy shareholders and may result in a decline in share prices (although in theory it shouldn't; if the company keeps the money, the value of the shares ought not to decline; nonetheless, shareholders expecting dividends may sell and these sales will exert downward pressure on share prices, at least in the short term). On the other hand, paying the dividend will anger politicians in the United States (not only President Obama) and may encourage the adoption of legislation that will cause greater harm to BP in the long term. 

But there is more to it.  In truth, the pressure from the US Government is effectively putting the Board and shareholders on notice about the extent of the liability associated with the spill.  This will force the Board to consider legal issues associated with the payment of the dividend.  The law on dividend payments indicates that unrealized losses must be taken into account when paying the dividend.

BP is incorporated not in Delaware (unfortunately for BP) but in England and Wales.  The law with respect to dividends, therefore, arises from the Companies Act of 2006.  Section 830 provides that dividends may be paid "only out of profits available for the purpose."  This amount essentially equals realized profits (not otherwise distributed or capitalized) less realized losses.   Section 831 imposes additional restrictions on public companies (including the obligation to take into account net unrealized losses). 

In addition to the Code, dividends are regulated under common law and subject to fiduciary obligations.  This likewise may require the Board to take into account unrealized losses.  As a memo from Norton Rose described:  "the directors must consider whether, subsequent to the relevant balance sheet date, the company has suffered losses which might affect the company’s ability to make a distribution."

The Board and its shareholders are now aware of the growing liability associated with the spill.  While it is far too early to quantify these liabilities, some possibility exists that they will exceed the Company's profits (as the term is used in the Companies Act) or its assets (some have put potential liability at $80 billion but in fact no one knows what the final number will be).  Thus, directors could, if they authorize the dividend, be potentially liable and shareholders with knowledge could potentially be obligated to pay the amount back (see Section 847 of the Companies Act).  

Payment of the dividend may anger politicians but it also may result in legal liability.  While the former is a judgment call, the latter is not.  Directors will not order the payment of a dividend to the extent they have any risk of personal liability.  And, after that sentence was written, BP in fact announced that it would not pay the dividend and would in fact place $20 billion in a fund to be used to pay claims connected to the spill. 

Wednesday
Jun162010

BP, the Dividend and the Board (Part 2)

The Company has a long history of paying dividends, having done so on "ordinary shares in each year since 1917."  Moreover, BP has committed to continued payment of dividends.  See Form 20-F, March 3, 2010, at 94 ("In 2000 and thereafter, dividends were, and are expected to continue to be, paid quarterly in March, June, September and December."). 

BP has stated that its policy with respect to dividends is to "return to shareholders all free cash flow in excess of investment needs, all other things being appropriate. This has typically been done through a mixture of dividends and buybacks."

In 2008 and 2009, BP paid a dividend of around $10 billion.  As the Company's Form 10-F noted:

  • Dividends and other distributions to shareholders The total dividend paid to BP shareholders in 2009 was $10,483 million, compared with $10,342 million for 2008. The dividend paid per share was 56 cents, an increase of 2% compared with 2008. In sterling terms, the dividend increased 24% due to the strengthening of the dollar relative to sterling. We determine the dividend in US dollars, the economic currency of BP.
The Company announces dividends four times a year.  During the period of the oil spill (the explosion at the platform was reported on April 20), the Company has already announced one dividend ($0.14/share), to be paid on June 21.  See Form 6-K, Report of Foreign Issuer, April 27, 2010 ("BP today announced a dividend of 14 cents per ordinary share to be paid in June.  The corresponding amount in sterling will be announced on 8 June 2010, and calculated from the average of the market exchange rates for the four dealing days commencing on 2 June 2010.  Holders of American Depositary Shares (ADSs) will receive $0.84 per ADS. The dividend is payable on 21 June 2010 to shareholders and ADS holders on the register on 7 May 2010.").  The next is slated for July 27.

 

It is this $10 billion or so of payouts that has attracted the attention of the Administration. With the costs mounting from the oil spill, the cash otherwise paid as a dividend might be needed to pay off some of the cleanup costs.  In addition, it amounts to available cash that can be used to pay off those in the Gulf already seeking compensation for the consequence of the spill (fishermen, oil workers, business owners).  In response to the pressure, reports indicate that the Board is considering a change in dividend policy. According to the NYT
  • A person with direct knowledge of the board’s discussions said on Monday that the board was considering three possible options: suspending payment of the dividend for two quarters, paying the dividend in bonus shares rather than cash, or placing an amount equal to the dividend payment in escrow while continuing to pay for the cleanup separately. Under the last option, BP would not tap the escrow fund unless the cost of cleanup work and claims exceeded what it could pay out of its regular cash flow. This option, the person said, could offer some reassurance to both Washington and to shareholders that BP will meet its financial obligations to both.
Will they change the dividend?  Probably but not necessarily for the reasons most are suggesting.  We'll explore that in the next post.
Wednesday
Jun162010

BP, the Dividend, and the Board (Part 1)

BP has been under pressure from the President, Barak Obama, to not pay a dividend.  The decision is one that falls to the BP board.  The board consists of 15 directors, five from management.  The CEO and Chair are, as is typical, separated, with the current chair (Carl-Henric Svanberg) coming from the ranks of the non-executive directors. 

Thus a majority of the directors are not members of management.  This is consistent with Section 3.4.1 of the Company's governance policies.  As the provision provides:  

  • Over half of the directors, excluding the Chairman, will comprise Non-Executive directors who are determined by the Board to be independent in character and judgement and free from any business or other relationship which could materially interfere with the exercise of their judgement.

Are these directors independent in a manner consistent with US definitions?  Unclear.  As BP has described:

  • BP's board governance principles require that all non-executive directors be determined by the board to be 'independent in character and judgement and free from any business or other relationship which could materially interfere with the exercise of their judgement'. The BP board has determined that, in its judgement, all of the non-executive directors are independent. In doing so, however, the board did not explicitly take into consideration the independence requirements outlined in the NYSE's listing standards.

Certainly, with respect to fees, the board is not, by US standards, excessively paid.  In 2009, most of the directors made somewhere in the vicinity of $150,000 (100,000 -110,000 pounds sterling), although the chair is paid 750,000L.  See Form 20-F, March 3, 2010, at 88 ("Mr Svanberg received the basic non-executive director fee and transatlantic attendance allowance for the period between his appointment and his assumption of the role of chairman on 1 January 2010. On his appointment as chairman in 2010, the chairman’s fee increased to £750,000.").

Carl-Henric Svanberg was appointed to the board in September 2009. At the time of his appointment, the remuneration committee looked at a comparison of remuneration for FTSE and international chairmen in determining his fee. The committee determined that in common with the previous chairman, he should receive the use of a chauffeured car, a maintained office for company business and security advice. In addition, the committee recognized that the appointment was to be Mr Svanberg’s main commitment and as he would be performing a proportion of his duties from Sweden, limited but appropriate secretarial support in Sweden would be provided. Mr Svanberg is also eligible for a single relocation allowance of up to £100,000 to cover expenses incurred in relocating to London from Sweden.
          Mr Svanberg received the basic non-executive director fee and transatlantic attendance allowance for the period between his appointment and his assumption of the role of chairman on 1 January 2010. On his appointment as chairman in 2010, the chairman’s fee increased to £750,000.
Friday
Jan082010

The Homeless and Budget Cuts

Among other things, I sit on the board of the Colorado Coalition for the Homeless.  It is an organization that is in the eye of the storm when it comes to servicing the homeless population in the Denver metropolitan area.  Despite a recession that has put increased demands on the services provided by the Coalition (mostly housing and medical care), the organization has undergone severe budge cuts, mostly because of the shortfall in revenue at the state level.  It is a very unfortunate development given the burgeoning homeless population.  For an article on the budget cuts and consequences, see Colorado homeless coalition announces painful cuts.  

Sunday
Jul262009

Starbucks and Social Responsibility:  Redux

We have occasionally written on this Blog about Starbucks.  Starbucks has had a rough time financially recently, even before the current crisis caused cutbacks among latte drinking professionals.  We noted that part of the problem came from the apparent decision by Starbucks to market itself as a commodity.  The problem with the approach is that there are others that make a decent latte.  Moreover, with the decision by McDonalds to insert baristas into its 14,000 shops, the commodity competition was going to get even worse.

Somehow, Starbucks needed to be anti-commodity.  There needed to be some unique reason to spend the extra amount for a latte at Starbucks rather than a cheaper version at McDonalds.  We suggested that the answer was Social Responsibility.  Customers of Starbucks coffee (at least some of them) would remain more loyal if they thought their purchase had some benefit that transcended a caffine jolt or a sugar burst.  While Starbucks has a page on its Internet site that trumpets social responsibility, we noted that there was little evidence of this in the assorted establishment (beyond the small sign above the Ethos Water bottles).

We don't know if management at Starbucks reads The Race to the Bottom, but we have to admit that much has changed.  In a recent visit to some Starbucks in Denver, it was subtly apparent that the Company was putting greater emphasis on Social Responsibility and on health.  One piece of evidence was a sign informing clients that:  "You buy more trade certified coffee than anyone in the world."  There was also a discrete yet noticeable placard that advertised how purchases at Starbucks would result in increased funding for Africa.  Purchases resulted in a contribution to the Global Fund.  Moreover, almost any purchase resulted in a contribution, including a 5 cent contribution for each use of a Starbucks card. The medium sized cup contained a message that 65% of its coffee purchased from farmers "who are good to their workers, community and planet" and that Starbucks was working on lifting the number to 100%.

With respect to the environment, the store announced that the purchase of a tumbler would result in a 10 cent discount and would save "another paper cup every time."  Their cups, by the way, note that they are made with 10% post-consumer recycled fiber.

There was also a sign that promised the food not only tastes better but that it is better.  This suggests that the Company is using healthy ingredients, although we'd like to know a bit more about this.  There is some information on the web site but it should be more apparent in the store.  The approach is a page from Chipotle that lets customers know the food is healthy and produced, generally, under humane conditions.

We will continue to watch.  Starbucks announced that it had a good third quarter so maybe the approach (along with many other changes) is already showing results (and showing that social responsibility can be good for the bottom line).  In the meantime, we would offer one additional suggestion.  Every store has a set of shelves that offer for sale assorted coffee paraphernalia, particularly ugly coffee mugs.  Can't a portion of the space be used to sell goods from crafts people in low income countries, perhaps in partnership with someone like 10,000 Villages?  If I knew my dollars were helping an artisan in Africa, I might buy the ugly coffee cup at full price rather than wait until it gets moved to the discount rack on the bottom shelf.

Thursday
Feb052009

Starbucks Selling A Plane

We've been talking about Treasury's efforts in the area of executive compensation.  The use of private aircraft illustrate the problems in this area.  Starbucks and Citigroup both opted to do without a corporate aircraft.  Needless to say, the interesting thing is not the decision itself but the lateness in the day for opting to do something seemingly obvious.

Starbucks is closing more stores (300) and reducing the number employees (6700).  Buried in the WSJ article was a mention that the company was also planning to sell its private aircraft.

  • Starbucks also said it put its Gulfstream 550 aircraft up for sale last week, just after the plane was delivered last month. The company had been criticized for buying the plane, in light of all the store closings and worker layoffs.

Buying the plane in the first instance is worse than John Thain spending $1.2 million on his office suite.  At least Thain did so back in January 2008, before the bottom fell out.  Starbucks can't say the same thing.  As it struggles with downsizing and lower earnings, it chose this time to buy a private aircraft.  It's not far from the auto companies flying to Washington in their private jets to ask for bailout money. 

As usual, the unanswered question is the oversight of the board.  And this is not the only company where the question needs to be asked.  Citigroup has announced that it won't take delivery of a $42 million jet.  The question is why, in this climate, it thought to buy the plane in the first place. 

Surely the board of Starbucks (and Citigroup) ought to be more involved in the trials and tribulations of the company and ought to be sending a message that this is not the time for profligate spending.  Apparently not. 

Tuesday
Jan272009

Starbucks and Social Responsibility: The Right Direction

We have written often on this Blog about the wrong headed business approach by Starbucks in combating its declining revenues.  In addition to a decline of business from the recession, Starbucks has had to confront growing competition, most noticeably from McDonalds.  The Seattle-based coffee company has largely fought back through small discounts and free syrups, treating its product as a commodity.  The continued bad news suggests that the approach has not worked.

We've noted on this Blog often enough that Starbucks needs to have a strategy that is not commodity based.  If a latte at Starbucks is just another latte, then it's hard to justify paying a higher price for the same coffee drink at McDonalds (which is weathering the recession nicely) or any other competitor.  The right strategy for Starbucks is to stress social responsibility, that drinking a latte at Starbucks is somehow making the world a little bit better.  Indeed, we've held up as a model Chipotle, the burrito maker based in Denver.  Chipotle is not cheap but it stresses free range meat and organic beans, along with local philanthropy.

We note some developments, however, that suggest Starbucks is getting the message.  On election day, Starbucks provided a free cup of coffee, a promotion that seemed highly successful.  More recently, Starbucks is promising a free cup of coffee to anyone who does five hours of volunteer work.  In addition, Starbucks now allows customers to register for a Red Card, with a contribution made to the Global Fund on every purchase.  In other words, it's not necessary to purchase certain drinks; every purchase results in a contribution.

It is clear that Starbucks is ramping up the social responsibility side of things. This is something that needs to be constant.  Perhaps, for example, there can be a free cup of coffee promotion every week.  As Starbucks gives customers a sense of accomplishment each time they consume products at one of the stores, they will have a reason to come back and sidestep a competitor.

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Friday
Dec122008

Starbucks and Social Responsibility: Free Flavors Aren't Working

The news at Starbucks keeps getting worse. Starbucks has been suffering, with declining sales and anticipated competition from the likes of McDonalds.  How has the company been doing?  Not well. As the WSJ has noted: 

  • New figures released by the company show that, instead of the bottoming out Starbucks predicted in October, the company's same-store sales have gotten worse. Though its overall revenues have grown, sales at U.S. stores open at least a year fell 9% in October and November from a year earlier.

What is the plan to fight back?

  • Starbucks, a brand that encouraged consumers to trade up, is changing tack after discovering that its most faithful customers are saving money in part by making fewer visits to the chain. It recently launched a loyalty card and other promotions that offer customers cheaper drinks and allow it to target the chain's most-frequent visitors, who come to Starbucks an average 16 times a month.

In addition, there is apparently an aggressive cost cutting program underway. 

In the end, as we have noted, this is what happens to a high end luxury that is largely indistinguishable from its competitors.  For Starbucks to buck the trend, it needs a different strategy.  Social Responsibility is this company's ticket to profit maximization.  It has taken small steps in that direction (a nickle to the Global Fund for certain drinks and free coffee on election day) but clearly views the strategy in a tepid fashion.  The benefits of the strategy will take time to sink in.  The longer the delay, the longer the bad news will likely last.

Saturday
Nov292008

Starbucks, Social Responsibility and the Global Fund

We have long pointed out that Starbucks needed to recast its strategy if it intended to fight back from the declining sales and the onslaught of competition, most noticeably McDonalds.  We have criticized the emphasis on gold cards (although we were rewarded with one during an experiment in Denver) and free flavors, noting that the approach did little more than treat lattes as commodities, a losing strategy.  The winning strategy was to make a Starbucks latte an experience, to give people a reason to seek out its product rather than go to one of the many other dispensers.

As part of that, consumers needed to know that a purchase at Starbucks would make a difference.  Social Responsibility in short.  Free coffee on election way provided some evidence that this was a winning strategy.  We have held up Chipotle (a chain begun here in Denver) as an example of the successful use of this strategy.  The burritos at Chipotle are not cheap but consumers are likely aware of the organic nature of the ingredients and the commitment to free range meat and poultry.

With that in mind, we note that Starbucks seems to be moving in that direction.  A Friday purchase at a Starbucks in Dummont, Colorado, right of Interstate 70, revealed, on the sleave of the chai, that the purchase of certain drinks would result in the contribution of 5 cents to the Global Fund, a highly respected organization combating a number of diseases including AIDs.  A subsequent email (the same day and inserted below) repeated the offer.  So does the Internet, where the location of participating Starbucks can be found.

The approach is a good beginning but very limited.  The contribution only occurs upon the purchase of three drinks, Espresso Truffle, Gingersnapp Latte, and Peppermint Mocha Twist.  The program also, apparently, expires on January 2.  It would be far better for Starbucks to create a culture of Social Responsibility that applied to all purchases in the stores.  In other words, customers would know that every purchase made some type of positive contribution.  But hopefully Starbucks will see some type of improvement in sales as a result of this promotion.  Maybe then the company will realize that it needs to by a much broader, systematic approach to the Starbucks experience.

And, maybe, Starbucks will finally realize that it needs to provide free Internet.

 

 

 

'Tis better to give and receive. Starting November 27, every time you buy a (STARBUCKS)RED EXCLUSIVE beverage at participating US and Canada locations, we'll give 5¢ to the Global Fund to help save lives in Africa. And in support of World AIDS Day on December 1, we'll donate 5¢ of every hand-crafted beverage we sell that day at participating US and Canada locations. Together, our nickels can really add up. Make your commitment at the (STARBUCKS)RED Community today.

Saturday
Nov152008

Starbucks and Social Responsibility

Starbucks is again in the news and it isn't pretty.  The company continues to hemorrage, with profits falling and same store sales dropping. 

  • The company's fourth-quarter report didn't do much to bolster investors' confidence. Profit fell 97 percent, hurt by hefty charges for closing about 600 U.S. stores and 61 locations in Australia. Same-store sales, or sales at locations open at least a year, dropped 8 percent in the U.S. as fewer consumers came in and those that did bought less.

The gold card experiment in Denver has been abandoned, replaced by a card that costs $25 a year in return for a 10% discount on most purchases and free Internet.  Some analysts speculate that in a recession, sales of $4 lattes will continue to fall.  Share prices have already fallen dramatically, with the price cut in half since the beginning of the year.  

Starbucks has been trying to stem the fall by competing as a commodity.  Customers have been offered small emoluments in an effort to generate business.  Loyalty programs have been commenced.  Free flavors and an occasional free latte are the primary weapons used to address declining sales.  But from all accounts, it isn't working.

What can and should Starbucks do?  The company should compete not as a commodity but as an experience.  As part of that, stores should be better designed to encourage in house consumption.  Some of the newer, smaller Starbucks are downright uncomfortable, with chairs and tables jammed into small spaces.  This would also mean providing free Internet, a step taken by almost everyone (including, by the way, some grocery stores and McDonalds franchises) except, apparently, Starbucks.  In addition, however, the company should focus on social responsibility and advertise the social benefits of consuming Starbucks coffee.  The size and volume of the company means that it can devote far more resources to social responsibility than its competitors.  Among other things, the company should replace the tacky nick knacks now sold in all of the stores with goods that resemble the model employed by 10 Thousand Villages, selling goods produced by crafts people in third world nations.

The appropriateness of the approach can be seen in part from the successful decision to offer anyone who voted a free cup of coffee.  The Monday earnings conference indicated that this was a highly successful campaign.  While the success may have resulted from the distribution of a free product, it helped that Starbucks was identified with socially good behavior -- voting in the election.  Moreover, given the likely client base of Starbucks, the company essentially shared in the Obama victory.  The campaign shows that appealing to customers on the basis of social responsibility works.

Yet from all indications, Starbucks intends to fight the downturn with Italian sounding smoothies and loyalty programs.  The earnings conference mentioned social responsibility and increases in the purchases of free trade coffee.  But it was a mere mention and there was no significant sign of social responsibility in the stores themselves (at least the ones I visited).  The current strategy is short sighted and one that will seem even more short sighted when McDonalds (which is seeing large increases in same store sales) begins stepping up sales of specialty coffee.

Friday
Aug222008

Starbucks and Social Responsibility: Loyalty Cards Just Aren't Working

Starbucks is floundering.  The latest reports indicate that the approach instituted over the last six months to stave off declining earnings through closed stores, new products and loyalty programs, is not working.  Earnings are down and at least one large shareholder has sold, a vote of no confidence in the company.  All of this is no surprise.  We suggested as much on this Blog.  In many ways, the approach has been self defeating and inconsistent.  To the extent Starbucks is a commodity, the closing of 600 stores will only make that commodity harder to find (something that will be an even bigger problem when McDonalds has baristas in all of its franchises). 

Starbucks ought to be competing for customers not with loyalty cards but through social responsibility.  Social responsibility here is a profit maximization strategy.  It would encourage customers to continue to frequent the chain not because it necessarily makes the best latte but because it is the socially responsible thing to do.  We have raised Chipotle as a model.  At least one blog reports that only 6% of the company's stock is fair trade.  Another possible model?  Ten Thousand Villages and their emphasis on selling products designed to improve the livelihood of disadvantaged people in developing countries.  These are both places that make money but allow their customers to feel like the expenditures have a purpose beyond mass consumption.     

What might Starbucks do?  Perhaps some of the shelf space currently occupied by mostly ugly seasonal mugs and other often useless bobbles could be taken up by Free Trade products.  Emphasis on fair trade coffee is another place to put energy.  With the emphasis on music, what about musicians in developing countries?  There is no obvious answer here.  But it is an avenue that needs attention, at least as much as the new "gold card" promotion (being tried here in Denver).

Tuesday
Aug122008

Chipotle and Social Responsibility

When does social responsibility and profit maximization converge?  At Chipotle, the burrito manufacturer headquartered in Denver.  The first Chipotle opened 15 years ago.  Since then, the chain has grown to 778 stores with sales of $1.1 billion.  With Bennigans in bankruptcy and others skirting financial disaster, Chipotle stands out as a raging success. 

Why? 

Needless to say they make a good product.  But that's not the whole story.  As we have discussed, they emphasize health (using organic ingredients), local produce (striving to buy 25% locally), and animal care (the meat is free range).  In other words, eating a burrito is more than eating a burrito.  Its promoting local farmers and helping to ensure adequate care of animals. 

Now we can add one more.  Anyone who goes to the same store on a regular basis notices that there is incredible stability in the employees who work there.  In my Chipotle (seventh and Colorado in Denver), I am recognized every time I go in.  It adds to the experience without any doubt.  One suspects that Chipotle must treat its workers reasonably well to engender the apparently low lever of worker turmoil.  A recent article in the Rocky Mountain News confirms this.  According to the paper,   

  • Many of the store management employees who have stuck with Chipotle since the early days have benefited as well - Chipotle offers a two-month paid sabbatical after 10 years of service, and a company car for all restaurant managers who have been with Chipotle at least four years.
  • There's also the potential for a stock option payoff. Chipotle distributed 774,150 shares among salaried employees ahead of its January 2006 IPO, with 456,150 going to nonexecutive employees like store managers, according to filings with the Securities and Exchange Commission. Under terms of the grant, recipients can't exercise their options until early 2009
Treating employees well.  That is another reason why the burritos at Chipotle taste just a little better. 
Tuesday
Aug122008

Social Responsibility and PAX World Management

We occasionally delve on this Blog into topics relating to social responsibility.  Much of our analysis involves the relationship between social responsibility and profit maximization.

The importance of social responsibility can be seen with particular clarity in the mutual fund area.  Socially responsible funds (SRIs) attract investors by promising to engage in socially responsible investing (with the phrase individually defined by each fund).  The usual notion is that investors agree to accept a reduced return but are promised an investment portfolio that meets certain socially responsible criteria.  And, in fact, as a group, the SRIs underpeform other mutual funds.  See Consumer Reports, Principles v. Performance, May 2008 ("And our analysis bore this out: In the past five years, SRI funds returned 11.1 percent annually, while all domestic equity funds returned 14.5 percent . . . . And only 15 percent of SRI funds with a five-year track record returned more than that."), and typically have a higher expense ratio.  While there are exceptions, therefore, investors as a group essentially pay for the costs of socially responsible investing.

As a result, a fund that promises to engage in socially responsible investing but reneges on the promise is doing more than merely violating a policy.  This issue came up in connection with the SEC's recent action against Pax World Management.  In Pax World Management, Investment Company Act No. 38344 (admin proc July 30, 2008), the Commission issued a cease and desist order (and imposed a civil penalty of $500,000) against a fund that violated its socially responsible criteria.  As the Commission found:

  • At all relevant times, investment adviser Pax World represented to investors and to the boards of the mutual funds it advised (the "Pax World Funds" or the "Funds") that it complied with various "socially responsible investing" ("SRI") restrictions, including, among other things, that it would not purchase for the Funds securities issued by companies that derived revenue from the manufacture of weapons, alcohol, tobacco or gambling products. Pax World acted contrary to these representations and violated the Funds' SRI restrictions from 2001 through 2005 when it purchased for the Pax World Growth and High Yield Funds ten securities that these Funds' SRI restrictions prohibited them from buying, including securities of companies that: (1) derived revenue from the manufacture of alcohol and/or gambling products; (2) derived more than 5% of their revenue from contracts with the U.S. Department of Defense; and (3) failed to satisfy the Funds' environmental or labor standards. During this period, Pax World also failed to consistently follow its own SRI-related policies and procedures with respect to these two funds that required that all securities be screened by Pax World's Social Research Department prior to purchase to ensure compliance with the SRI disclosures. In addition, during this period, Pax World did not consistently adhere to other SRI-related policies and procedures, including continuously monitoring fund holdings. As a result of conduct during the period from 2001 through 2005, the Pax World Funds held at least one prohibited security at all times from 2001 through early 2006.
In addition to purchasing securities that violated the socially responsible criteria, Pax World committed to "continuously" monitor fund portfolios for compliance with the policies.  The Commission found that Pax World had "no policy or procedure for continuously monitoring the portfolios until 2004."  And, when the policy was adopted, "the Company did not consistently comply with this policy."  The advisor also, in at least some cases, failed to disclose information about the noncompliance to the board of directors of the respective funds.  The Commission found a violation of Section 206(2) of the Advisers Act (prohibiting an adviser from engaging in "any transaction, practice, or course of business which operates as a fraud or deceit upon any client").

Several things ought to be noted.  First, the Commission brought an administrative proceeding, not an injunctive proceeding.  The difference is significant both in appearance (a court order is perceived to be a more severe sanction) and in practice (court orders are enforceable through contempt, administrative proceedings are not).  Second, the Commission issued a cease and desist order for violations of Section 206 of the Advisers Act.  There is no private right of action for a violation of the section.  See Frank Russell Co. v. Wellington Mgmt. Co., 154 F.3d 97  (3rd Cir. 1998).  At the same time, the Commission did not bring an action for violating Rule 10b-5 even though the language of the two sections is largely identical.  

It's not quite right to call this action a slap on the wrist.  For any reputable adviser (and Pax World is), an enforcement proceeding of any kind by the Commission is damaging, particularly to reputation.  And, as the Commission noted, Pax World engaged in significant remedial acts.  Pax World replaced management, developed new procedures and implemented a new computer softward for SRI compliance.  Nonetheless, the severity of this offense was not recognized in the proceeding.  For the relevant time periods, the particular funds were, in fact, not socially responsible funds.  During the relevant time period, investors accepted the risk of a lower return without the promised consideration, that is that the funds would invest consistently with the stated socially responsible policies.  It sends a terrible message and, in the context of decisions like shareholder access, suggest a low level of importance placed on shareholder rights. 



Monday
Jul072008

Starbucks, Store Closings and Social Responsibility

We write regularly about Starbucks on this Blog. The latest news from the mandrake of the three dollar (or more) cup of coffee is that it will close 500 more stores, apparently in recognition that some stores are cannibalizing the sales of others. We have no opinion on this, lacking any expertise into, or insight about, the management of 11,000 outlets. But we offer this observation. When McDonalds rolls out the plan to insert baristas in its 20,000 franchises, Starbucks will incur unparalleled competition. To the extent the product of McDonalds and Starbucks is considered a commodity, convenience and price will control the choice of many latte consumers. By closing stores and slowing expansion, Starbucks increases the convenience of the McDonalds franchise.

We have taken the position often here that Starbucks needs to use its huge corporate presence to promote socially responsible causes as a means of differentiating its product, whether economic, in the case of employees and coffee producers, environmental, whether in the coffee growing process or in the process of coffee consumption, or health, whether by using organic or locally grown products. This is what the burrito maker, Chipotle, does. But if Starbucks insists on treating its product like a commodity, it must have in place a strong commodity strategy. By closing stores, purchase of the commodity becomes a bit more difficult and threatens to lose customers to an outlet that is more convenient and not necessarily a Starbucks.

Friday
Jun202008

Starbucks, Social Responsibility, and Profit Maximization

Starbucks is in trouble.  Per store earnings are falling.  Competition is on the horizon, with McDonalds planning to insert baristas into its 20,000 franchises.  Starbucks coffee, as a commodity, will find the competition from McDonalds stiff, with the fast food giant likely to be able to make high quality coffee drinks at competitive prices in often more convenient locations.

Starbucks has become a commodity.  80% of the orders are consumed off premises.  In other words, most people coming into Starbucks are not coming in for the experience.  The company seems to recognize the consequences of this approach, deciding to expand more rapidly overseas where the statistics are the reverse.  80% of orders are consumed on premises.  In foreign countries, where homes and apartments are smaller and open spaces at a premium, Starbucks likely provides a meeting place that causes people to collect there and, concomitantly, buy and consume Starbucks products.  This is not true in the United States.

As we have noted, Starbucks is increasingly an outlier in the US because it does not offer free Internet access (Peaberry's in Denver does, Caribou Coffee does, so does almost every independent coffee shop I've entered).  This discourages those ubiquitous laptop users from planting themselves in the shop and buying product throughout the day.  Do a small survey.  Go into a variety of coffee shops (including Starbucks) and count the number of open laptops.  Over any protracted period of time, Starbucks will lose. 

How is the company responding?  Starbucks has started a loyalty program, allowing for the purchase of cards that provide modest benefits (free flavors, two hours of Internet usage).  In other words, as a commodity, they are trying to retain customer loyalty by offering small discounts.  This is a strategy that can be easily matched by competitors and does nothing to reward repeat customers or encourage coffee drinkers to stay on the premises.

It is the opinion of this Blog that to maximize profits, Starbucks needs to differentiate itself from competitors, not offer small economic emoluments that can be easily matched.  The answer is at Chipotle, the burrito company started here in Denver.  Chipotle is not cheap, with an ordinary burrito easily costing about $6 -$7 dollars.  Yet the company has robust growth in part because of the experience associated with eating in the establishment.  It is hard not to know that the burrito is made with free range chicken and organic ingredients, socially responsible and healthy.  Indeed, the company has just announced that it will begin to buy produce from local producers.  See Denver Post, June 19, 2008 ("This summer, Chipotle is purchasing 25 percent of at least one produce item for each of its stores from small and midsize farms within about 200 miles."). 

Chipotle has no loyalty program, no free guacamole.  But it does have increased earnings.  Rather than foregoing payments for flavors or soy milk, would Starbucks be better off using the funds to engage in more socially responsible activity and let customers know that the purchase of each latte results in a social good?  Ought Starbucks to place greater emphasis on employees (the company apparently already provides health benefits and options to part time employees) and let its customers know that each latte goes to the payment of a living wage?  This Blog thinks that it should and that the behavior will help earnings more than free soy milk. 

Saturday
Jun072008

Starbucks, Social Responsibility and Free Internet

We have often written on this Blog about Starbucks and the need for greater emphasis on social responsibility in order to retain customers, particularly as competition from McDonalds (which is planning to install baristas in 20,000 franchises) heats up.  As an aside, we have noted that Starbucks is behind the curve in failing to provide free Internet, something done at almost every other coffee shop (and numerous other merchants). 

Starbucks has put in place a loyalty card and this week began offering holders two hours of free Internet use (so writes Your Money, Loyalty Program Offers Freebies (but Read the Small Print).  It is a useful step but one that only illustrates the weaknesses in the company's approach.  Only those aware of the benefit will take advantage of it; it will be useful only to those with relatively short term Internet needs.  To attract and retain customers, Starbucks needs, among other things, to offer  free Internet, no strings attached. 

Thursday
May152008

Profit Maximization and Social Responsibility

The Journal on Monday included a story titled "Does Being Ethical Pay."  The thrust of the article concerned companies acting in a socially responsible manner and whether consumers would pay more as a result.  We have been harping on this subject with particular attention paid to Starbucks.  Starbucks is confronting problems of saturation but it is also confronting increased competition as other companies see the margins in selling expensive specialty coffees.  Moreover, for all of the problems, Starbucks had not yet even confronted the greatest threat:  The plan by McDonalds to put baristas in all 14,000 franchises.

Starbucks has become a commodity so customers will go elsewhere if the commodity is as good and either cheaper or more convenient.  The question for Starbucks is how to create increased customer loyalty that is impermeable to these factors.  It means transforming Starbucks from a commodity to an experience.

Support for this comes from the WSJ article.  The Journal studied consumer reaction to ethically produced goods.  It defined these goods as follows:

  • For our purposes, "ethically produced" goods are those manufactured under three conditions. First, the company is considered to have progressive stakeholder relations, such as a commitment to diversity in hiring and consumer safety. Second, it must follow progressive environmental practices, such as using eco-friendly technology. Finally, it must be seen to demonstrate respect for human rights -- no child labor or forced labor in overseas factories, for instance.

The study looked at a number of problems, in particular coffee, and sought to determine whether consumers would pay more for ethically produced products.  The results, with respect to coffee?

  • After reading about the company and its coffee, the people told us the price they were willing to pay on an 11-point scale, from $5 to $15. The results? The mean price for the ethical group ($9.71 per pound) was significantly higher than that of the control group ($8.31) or the unethical group ($5.89).

Of course, not all consumers felt this way.  Moreover, the degree of the differential varied depending upon the attitudes of the consumers with respect to their expectations about the ethical behavior of companies.  As the article noted:  "People with high expectations doled out bigger rewards and punishments than those with low expectations."

In other words, ethical behavior can pay.  Starbucks can learn from this lesson.  To the extent it puts more emphasis on social responsibility and less on its unique blend of coffee (which does not taste all that unique), it will do a better job creating customer loyalty and inducing them to pay a price higher than that charged by competitors. 

 

Saturday
May102008

Starbucks and Social Responsibility: Not Getting the Message

Starbucks is having a tough time.  The company announced that earnings would not meet expectations.  Same store sales fell for the first time since the company began reporting the data in 2004.  The reason?  "[W]eakness in the U.S. consumer environment," particularly declines in California and Florida, places feeling the brunt of the downturn in the housing market.  One consequence is that it plans to open fewer stores.  The news is particularly bad since competition from McDonalds, which intends to include baristas in every fast food restaurants, has yet to occur.

This is further proof of the commoditization of the Starbucks product.  Despite all of the efforts at improving quality, the company puts out a commodity that can be obtained in other coffee stores and restaurants, often at a lower price.  The company has not done a particularly good job of emphasizing why the purchase of a latte from Starbucks is better than in other locals.  While the effort to market a special blend of coffee (no doubt expensive but likely to be ineffective) or improve the skills of the baristas may result in a modest improvement in quality, it is unlikely to attract in (or keep) the hordes of coffee drinkers that the company needs to maintain its earnings. 

Some effort has been made to expand the menu, with sports drinks (in partnership with Pepsi) and smoothies, an apparent stab at the health conscious market, and "a more-indulgent sweet, icy beverage developed with an Italian company."  But while none of these products has yet reached the stores, they look to be little more than additional commodities, something that may bring in those seeking the convenient but not resulting in strong consumer loyalty. 

Social responsibility is the answer.  To the extent coffee drinkers think they are improving the world through the purchase of a Starbucks latte, they will be less likely to abandon the company when similar products start to flow at places like McDonalds.  Our poster child for this approach is Chipotle, where eating a burrito is more than a culinary experience.  From the looks of it, it will take some additional bad quarters for the company to realize that it needs to take a different approach against the competition, something that will include social responsibility and, by the way, free Internet.

Tuesday
Apr222008

Investment Companies and Social Responsibility

The topic of social responsibility, something occasionally explored on this Blog, is not limited to operating companies.  A couple of weeks ago, Fidelity Funds held their annual meeting.  Shareholders had submitted proposals designed to promote human rights.  What exactly did the proposal state?

  • In order to ensure that Fidelity is an ethically managed company that respects the spirit of international law and is a responsible member of society, shareholders request that the Board institute oversight procedures to screen out investments in companies that, in the judgment of the Board, substantially contribute to genocide, patterns of extraordinary and egregious violations of human rights, or crimes against humanity.

Management opposed the proposal, mostly because it interfered with the investment choices of the funds.  "The Fidelity Funds Board of Trustees recognizes and respects that investors, including those investing in this Fund, have other investment opportunities open to them should they wish to avoid investments in certain companies or countries. Shareholders of the Fund, however, have chosen to invest in this Fund based on its specific stated investment policies. If adopted, this proposal would limit investments by the Fund that would be lawful under the laws of the United States. For this reason, the Board of Trustees recommends that you vote "AGAINST" this proposal."

The proposals were rejected but not after displaying considerable support.  As the WSJ reported:

  • In results revealed at an emotionally-charged meeting this morning in Boston, 25% of the shares in Fidelity's $12.3 billion Mid-Cap Stock Fund voted for the proposal. The tally was 21% in Fidelity's $12.5 billion International Discovery fund, 22% in the $8.5 billion Overseas Fund, and 23% in the $4.4 billion Canada Fund.

Investors who want to invest in socially conscious funds can select funds that promise to invest accordingly as a matter of investment strategy.  Most investors, however, are more concerned with maximizing returns and not worried about investments in firearms or gambling or cigarettes.  But in competing for funds, it is possible to combine both and achieve a competitive advantage.  

Proposals like the ones considered by Fidelity theoretically can impair return.  But in fact, it is likely that the number of investments foregone as a result of the policy would be modest and that the funds could still produce a favorable return.  For investors selecting a fund, therefore, would it influence their decision to know that the investment companies had in place a system of ethics that sometimes, in narrow circumstances, resulted in the avoidance of investments that  "substantially contribute" to immoral behavior such as "genocide, patterns of extraordinary and egregious violations of human rights, or crimes against humanity?"

Perhaps.  Said another way, social responsibility can be good for the bottom line.