Qantas: A Case Study in Corporate Governance

INTRODUCTION

This paper will examine corporate governance issues from the perspective of the Australian international air carrier Qantas. It will be the thesis of this paper that Qantas is operating in a very difficult competitive environment. In order to maintain the firm's viability, this may mean unpopular tradeoffs with certain stakeholders will have to be negotiated.

This paper will be divided into four main sections. The next section will present an overview of corporate governance criteria and its importance. Section three will discuss Qantas' problems with corporate governance. The fourth and final section will present some recommendations for Qantas on how to address its corporate governance issues and maintain the firm's viability.

CORPORATE GOVERNANCE CRITERIA

Overview. Corporate governance can be defined as a code of practices and responsibilities implemented by a firm's executive management and board of directors. As such, corporate governance incorporates the entire accountability schema of an organization ("Enterprise"). It can be said to have two aspects. The first is governance and the second is conformance. The purpose of governance protocols is fourfold. First, to provide a strategic vision for a firm. Second, to ensure that a firm's objectives are being attained. Third, to ascertain that risks to a firm are properly managed. Fourth, to verify that organizational resources are being consumed in a responsible manner ("International").

Conformance has also been referred to as corporate governance. Conformance refers to firm compliance with officially codified regulations and laws, the firm's own best practices guidelines, and its accountability to shareholders, and to stakeholders in general ("International"). In addition, conformance can refer to such internal structures as the firm's officers, constitution and shareholders create. It can also refer to external factors such as the firm's clients, government regulators, and civil society organizations.

Organizations that function for the purposes of profit have usually prioritized improving shareholder value. This primary focus involves locating the equilibrium between risk, cost, and revenue ("International"). However, corporate governance theory demands that for-profit enterprises also seriously consider the effects of their business on other stakeholders. Thus instead of profit-seeking with a short-term focus, truly sustainable shareholder valuation would incorporate the needs of both extant and future members of the firm's community of stakeholders.

Background. The expression "corporate governance" was first introduced during the 1980s. However, the concept itself has a long history (B. Tricker 385). For instance, the Securities and Exchange Commission (SEC) in 1972 required US firms to create a standing internal corporate audit committee of the main directors' board. The committee was to include independent directors from outside the firm. Their purpose was to act as a liaison between the main board and the external auditor. This arrangement was to ensure that a firm's directors were informed of any problems that emerged between the finance department and the external auditor.

Early developments on corporate governance resulted from official government reactions to corporate malfeasance. For instance, in 1986, the now-defunct US investment firm Drexel, Burnham, Lambert attracted the attention of the SEC because of allegations of stock manipulation, failure to disclose ownership, and insider trading. These kinds of scandals were by no means unusual during the period (B. Tricker 387). The abuse of power by boards of directors and of executives, who were thought to be too powerful, led to a reconsideration of the way in which power is distributed at the summit of large-scale private sector enterprises. This reconsideration process led to the formulation of the first of the official corporate codes of conduct in the form of the UK's Cadbury Report.

The Cadbury Report was soon followed by best practices guidelines and codes of conduct in many other industries and countries. This burgeoning process seemed to confirm that concern over corporate malfeasance was prevalent and required considerably more attention (B. Ticker 388).

The following are the usual solutions that were proposed to address corporate governance issues:

The employment of independent non-executive directors was expanded.

The audit committee of the board was introduced.

The chief executive officer and board chairman's responsibilities were split.

Executive rewards were overseen by a remuneration committee.

New board members were selected by independent directors in conjunction with a nomination committee.

Accountability extended to periodic reporting on whether corporate governance objectives had been achieved. This was usually accompanied by an explanation if objectives were not achieved.

A philosophical difference emerged between corporate governance approaches in the US and in the UK. This difference centered on whether such rules should be mandatory and written into law or voluntary and left to the discretionary of individual firms. The former approach was taken in the US, where business practices were influenced by SEC requirements and the legislation of individual states. This approach was further extended with the introduction of Sarbanes-Oxley in the wake of the accounting scandals at Enron and other US firms in 2002 (B. Ticker 388; R.I. Ticker 30).

There is a perspective that holds that boards of directors should not act in terms of shareholder interest in isolation to other concerns. Thus stakeholder theory argues that profit-making enterprises are also obligated to consider other societal actors. These actors are members of the firm's stakeholder network who may be negatively impacted by the business. The next section will present evidence that corporate profitability, and serious inclusion of stakeholder concerns, are not mutually exclusive.

Criteria justification. Indeed, there are decades of corporate performance studies indicating a relationship between profitability and ethical business practice. Makower (1993) reports research testing the “Wall Street belief that having a good environmental record was costly to business and lowered points and returns.” The study selected 19 top-ranked firms from the Council on Economic Priorities (CEP) list ranking firms according to their record on social responsibility. These firms were compared against those of the bottom 34 firms. All firms were ranked using eight measures of economic performance. Makower (1993) reports that the top 19 firms outperformed the bottom 34 firms on all 8 measures. This suggests that a strong social performance record is not necessarily an obstacle to strong financial performance.

These results are echoed by other research. A 1997 study found that excellent employee, customer and community relations are more important than strong shareholder results for corporations that earned a place on the annual “Most Admired Companies” list published by Fortune (Waddock and Graves, 1997). In a different study, the same authors found a correlation between good environmental performance records and strong economic performance. The authors (1997) followed over 250 companies during a two-year period using independently developed environmental ratings. The authors (1997) reported that the relationship between environmental and economic performance strengthens with industry growth. This evidence seems to predict that a strong socially responsible business policy may actually help Starbucks' long-term profitability. At the very least, there is no evidence that a strong ethical record is an obstacle to corporate profitability.

CORPORATE GOVERNANCE PRINCIPLES AND QANTAS

Company overview. Qantas was established in 1920, and incidentally, the firm's name is an acronym meaning Queensland and Northern Territory Aerial Services. It is the world's second-oldest airline and the leading air carrier in Australia ("Our Company"). The firm has a significant international presence in 40 countries, which includes over 80 different destinations. The firm and its various subsidiaries carry an average of 30 million passengers per year.

Yet Qantas has experienced some significant economic difficulties in recent years. In fact, it began 2014 having its stock downgraded to high-risk junk status by both of the world's leading credit rating agencies (Flynn). The reason for the reduction was the significant competitive challenge being posed in the Qantas domestic market by Virgin Australia. Thus the prognostication is that Qantas will experience considerable loss of market share to its more aggressive competitor in the coming years.

The effect of the firm's downgrade will lead to an increase in the cost to obtain affordable credit. In addition, a change in the way banks credit Qantas accounts is expected to remove as much as $2.8 billion from the firm's cash balance. That is until recently Qantas was able to bank any cash paid for tickets before the passengers took their flights (Flynn). However, going forward, the credit will only be allowed after the flights are taken. Thus this further compounds the firm's already serious negative cash-flow problems.

Qantas first posted an after-tax loss in the 2011-12 fiscal year of $US244 million. This was notable as the first loss since the firm went completely private during the mid-1990s. However, its losses appear to be growing. The firm is also facing a record $US868 million loss before tax for the 2013-14 fiscal year (Flynn). A number of factors will likely prevent any recovery for the company in the first half of 2014. These problems include high oil prices, unfavorable foreign exchange rates, weak passenger demand, and increased carrying capacity.

Indeed oil prices have grown from a two decades average low of $US20 prior to 2002 to an average of over $US100 since. In addition, the excess seating capacity in international airline markets has significantly cut passenger costs (Dennis). Moreover, the cheap airfares market appears to be the only one that is growing. These factors make it extremely difficult for Qantas to earn enough income to pay for its expenses, much less generate a profit. According to its 2012 annual report, the firm recently had a record fuel bill of $4.3 billion.

The firm's weakening fiscal position is leading it to cut staff. In fact, Qantas announced plans to lay off 5000 workers and sell off assets such as its Melbourne Airport terminal (Whinnett). As many as 1500 staff cuts will be in upper management and a large number of these workers are expected to be let go by the end of March 2014 (Flynn). The company is also trying to obtain changes to the Qantas Sale Act. The Act mandates limits to foreign ownership of the firm to only 49 percent. Unfortunately, this legislation inhibits the company's ability to raise capital and improve its competitive position. It should be noted that the Green and Labour parties both oppose any changes to the Qantas Sale Act. In their view, it will only cause more job loss and lead to the loss of certain regional air routes. Indeed, a Green party leader argued that Qantas would have to guarantee jobs before receiving any government debt relief. But Qantas's problems are not unique. It's been reported that all of the world's international airlines are losing money. In contrast, Qantas has been competitive in domestic and regional markets, although the expansion of Virgin Australia may threaten that as well.

Qantas governance issues. Qantas has certainly conformed to traditional corporate governance in terms of creating a diverse board of directors and setting up committees for nominations, audit and safety, health, environment and security ("Annual Report"). The firm also has appointed 11 non-executive independent directors and has set up a remuneration committee. However, despite these measures, Qantas still has two serious corporate governance problems in terms of its stakeholder relationships. The first is serious labor disputes and the second is high levels of executive compensation.

Labor disputes. In the fall of 2011, there was a dispute between Qantas and the Transport Workers Union (TWU). The dispute was over a proposed legal challenge to Fair Work Australia's decision to end all industrial action. This challenge emerged in the wake of the firm's decision on October 29, 2011, to ground all of its flights (Wright). Qantas argued that labor action should be terminated because it would provide the airline with certainty. The following month, Federal court proceedings were initiated by the Australian International Pilots Association (AIPA) to obtain an order challenging the Fair Work Australia decision to end any industrial action.

The TWU decided to use arbitration to resolve its dispute with Qantas. Tony Sheldon, the union's national secretary, supported an aviation award that would cover both Qantas, and among other airlines, Virgin Australia and Jetstar (Wright). The purpose of the aviation award is to obligate the airlines to provide fair rates of compensation to their employees. This stipulation would cover the entire Australian aviation sector. However, the unions are also concerned that Qantas is outsourcing more of its operations to its low-cost Jetstar subsidiary.

According to Qantas, the firm's fleet was grounded due to pressures from within the aviation industry. Thus company management has argued that setting pay rates beyond what their competitors are paying would significantly harm its competitive position (Wright). However, Fair Work Australia prohibits the undertaking of industrial action during the arbitration period which could last up to four years. According to Qantas, bookings for the airline experienced a dramatic drop during the action and thus further hurt the business.

Executive compensation. Despite the firm's difficult position in recent years, its senior managers are earning extremely inflated levels of compensation. It's notable that these increases are occurring at a time when the firm's share price is falling (Hildebrand). Among the reported increases were eight executives who saw a single year collective income rise of 62 percent to over $14 million. Board fees also nearly doubled over a four year period, ending in 2011, to nearly $8 million. Qantas CEO Alan Joyce also saw a 71 percent increase in compensation, although some of it was contingent on meeting certain growth targets. These abuses have all occurred despite the existence of a remuneration committee dedicated to policing just these issues.

RECOMMENDATIONS

Unfortunately, providing recommendations for this particular firm may involve painful trade-offs for a number of stakeholders. Qantas is suffering the deleterious effects of operating within a high-cost, relatively low demand industry sector. Most firms will need to cut labor costs in such a situation and the recommended course of action for Qantas may be no different. Flynn suggested that the firm could offset its losses through the sale of additional assets such as Jetstar and the firm’s Frequent Flyer plan. It's not known whether this will be enough.

However, another recommendation could be for the Australian government to begin limiting air rights to foreign carriers under public sector ownership. These carriers are based mainly in Middle Eastern countries such as the United Arab Emirates (Flynn). They also bring in a fairly small number of foreign tourists relative to the number of Australian passengers they fly out (Dennis).

The firm could also abandon its goal of a two-thirds share of the domestic airline market. This is because current passenger capacity levels do not make this a cost-effective strategy (Dennis). A more drastic recommendation is to sell off the firm's international business operations to a company willing to accept operating in such a financially stressful environment (Flynn). In addition, a failure by Qantas International could lead to the formation of a new premium type airline modeled on Jetstar Gold. This type of transition could lead to cheaper wage rates and labor contracts (Dennis). They could also attempt other cost-cutting measures such as using secondary airports and yield management. But such a move would certainly be unwelcome by other stakeholders such as labor. Finally, Qantas senior managers could accept substantial pay cuts until the firm returns to profitability.

Works Cited

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Enterprise Governance Getting the Balance Right. Ifac.org, 2004. Web. Retrieved from http://www.ifac.org/sites/default/files/publications/files/enterprise-governance-gett.pdf. February 2014.

Flynn, David. "Qantas Gets a Second Slap Down to 'Junk' Status." Ausbt.com.au, 9 Jan. 2014. Web. Retrieved from http://www.ausbt.com.au/qantas-gets-a-second-slap-down-to-junk-status. February 2014.

Hildebrand, Joe. Qantas bosses' salary up $5m. Daily Telegraph, 10 October 2011. Web. Retrieved from http://www.perthnow.com.au/business/qantas-bosses-salary-up-5m/story-e6frg2qc-1226162701504. February 2014

International Good Practice Guidance: Evaluating and Improving Governance in Organizations. Ifac.org, 2009. Web. Retrieved from http://www.ifac.org/sites/default/files/publications/files/IGPG-Evaluating-and-Improving-Governance.pdf. February 2014.

Makower, Joel. E Factor. New York, NY: Random House-Times Books, 1993. Print.

Our Company. Qantas.com.au, n.d. Web. Retrieved from http://www.qantas.com.au/travel/airlines/company/global/en. February 2014.

Qantas Annual Report 2012. Qantas.com.au. 2013. Web. Retrieved from http://www.qantas.com.au/infodetail/about/investors/2012AnnualReport.pdf. February 2014.

Tricker, Bob. "Re-inventing the Limited Liability Company." Corporate Governance: An International Review, 19.4 (2011): 384–393. Print.

Tricker, R.I. "The Cultural Dependence of Corporate Governance." Keeping Good Companies, 64.1 (2012): 27.

Waddock, Susan and Graves, Sam. "Finding the Link Between Stakeholder Relations and Quality of Management." The Journal of Investing, 6.4 (1997): 20-24. Print. DOI: 10.3905/joi.1997.408435.

Whinnett, Ellen. "Qantas Set to Axe 5000 Jobs and Sell its Melbourne Airport Terminal to Negotiate Federal Assistance." Theaustrialian.com.au, 25 February 2014. Web. Retrieved from http://www.theaustralian.com.au/news/federal-government-set-to-push-law-on-majority-foreign-ownership-of-qantas-as-airline-set-to-axe-5000-jobs-and-sell-its-melbourne-airport-terminal/story-e6frg6n6-1226836427210. February 2014.

Wright, Jessica. "Qantas Pledge to Passengers: Four Years Strike Free." Smh.com.au, 24 November 2011. Web. Retrieved from http://www.smh.com.au/travel/travel-news/qantas-pledge-to-passengers-four-years-strike-free-20111124-1nwdt.html. February 2014.