April 29, 2007

The Ugly Secret Behind Your Child’s Halloween Chocolate

The West African state of Ivory Coast has prime growing conditions for cocoa trees and provides almost half of the world’s cocoa beans. The economy is dependent on the cocoa plantations and 40% of export earnings in Ivory Coast are attributed to the cocoa industry. In the last decade, the cocoa prices have been so low that the farmers were actually losing money on their crops each year. A 2002 study by the International Institute of Tropical Agriculture found that the average yearly wage for cocoa growers in West Africa ranged from US$30 to $110. Because of decreasing prices and exploitive middlemen, farmers look for ways to cut costs forcing them to obtain children for cheap labor. Last Fall, the New York Times published a brilliant (and wrenching) piece of investigation of such slavery in Ghana and Ivory Coast.

According to the 2000 Human Rights Report released by the US State Department, 15,000 children between the ages of 9-12 have been sold into forced labor on cotton, coffee and cocoa plantations in West Africa in recent years. It is estimated that 284,000 children are working on the cocoa farms in Ivory Coast. Some of these children are working on the family farm, but a large percent of the children are slaves that have been sold or lured into the industry, most from Mali. The children are working instead of getting an education and are also deprived of a childhood.

The International Labor Organization reported that many of the children are involved in hazardous work and unprotected. The children are required to use dangerous sharp machetes in order to cut down the branches of tall trees. They are exposed to the harmful pesticides that are applied to the plants and the children do not have proper protection. Often the bags of cocoa beans that the children are required to carry are taller and weigh more than the children themselves. The owners of the farms do not pay the children, do not adequately feed them and frequently beat them. The children are locked up, to prevent escape, in a small room where they all sleep often on wooden planks.

In 2005 the International Labor Rights Fund brought a district court action lawsuit against Nestle, Archer Daniels Midland and Cargill, three of the largest chocolate producers, on behalf of children form Mali. The companies are accused of the involvement in the trafficking, torture, and forced labor of children who cultivate and harvest cocoa beans that the companies import from Africa. The children claim that they were taken form their homes and brought to Ivory Coast to work as slaves. Two federal statutes allow victims of human rights abuses who live outside of the United States to sue US companies for violations of international law. The statutes are the Torture Victim protection Act and the Alien Tort Claims Act. Evidently the case, filed under the latter, is still pending since last year as a shareholder complaint at the shareholder meeting earlier this month indicates.

In 2001, congress passed an act to end the buying of cocoa that was produced by slave labor in the United States. The Harkin-Engle Protocol was the bill was to end the buying of slave-trade beans by July 1, 2005. But the main chocolate companies, Hersey, Mars/M&M’s, and Nestle, were unable to meet the deadline of the protocol. In 2007, there are still child slaves working on the cocoa farms in Ivory Coast.

The idea of child slavery could be supported by the classical model of corporate responsibility, which states that management's only role is to maximize profits within the letter of the law. However, this practice is evidently illegal according to the U.S. statutes above. Furthermore, the influential neoclassical model of social responsibility does not support the use of slavery in any circumstances. This model states that “the pursuit of profit is constrained by an obligation to obey a moral minimum” to avoid inflicting harm (Joseph DesJardins). According to Samlanchith Chanthavong at American University, “The connection serves to illustrate that the existence of misery in one part of the world and joy in another part are no longer divorced as nations are connected together in a globalized web of trade.”

There are actions that these companies can take in order to ensure that children are not being exploited on the plantations. In a country where more than half the population is illiterate, basic education of “cocoa children” takes on an even more critical significance for Ivory Coast’s future. Ultimately the companies in the cocoa industry can use their power and money to combat an issue that would produce a result that would be good for the entire country and society.

If companies would buy and demand Fair Trade Certified cocoa, farmers would have the resources that would allow them to eliminate child labor on their farms. The Fair Trade Labor Organization makes annual inspection visits to producer groups on its Fair Trade Register to ensure that the benefits of Fair Trade relationships are reaching the farmers. The Fair Trade Certified label guarantees that farmers and workers received a fair price for their product. The Fair Trade price means that farmers can feed their families and that their children can go to school instead of working in the fields. This label also insures that forced or bonded labor is not permitted, nor may children work in circumstances that could jeopardize their education or lead to them performing hazardous tasks. Cooperatives also give farmers access to price information giving them the independence to negotiate prices for themselves.

The ethical response to forced child labor would be for the companies to buy and promote fair trade cocoa instead of supporting the terrible working conditions that are present on the plantations that produce the beans that companies purchase. Until then, we are supporting the exploitation of children with our continued financial support of cocoa beans. The practice will not be stopped unless the American people, corporations, and the international community force a change in the chocolate industry.

Bank of America’s Unethical Credit Card Program

Bank of America has recently launched a new program where individuals who do not have a social security number can sign up for a credit card. As a result, this program gives an economic incentive for illegal immigrants to come to the United States. In order to be able to have access to this credit card, an individual has to have a bank account with Bank of America for three months with no overdrafts. These credit cards have a maximum balance of $ 500 dollars and the individuals have to pay interests rates exceeding 20 %.

Due to the fact that Bank of America’s new credit card program is one of the first from one of the major U.S. retail banks, it has received a lot of criticism. On February 22, 2007, Bank of America’s Chief Executive Officer Kenneth D. Lewis submitted an editorial to the Wall Street Journal in order to address the public criticism and to justify the company’s new credit card program. In his editorial, Lewis justifies the new plan by stating that it follows all of the rules set forth by the USA Patriot Act. Also, Lewis says that Bank of America is not targeting any one type of racial group, but are targeting consumers who do not have a credit history and who want to build one. While Lewis’s editorial seems to perfectly justify Bank of America’s new credit card program, there are troubling factors that seem to suggest that its new plan is acting unethically.

First, the pilot program for Bank of America’s new credit card was started in Los Angeles, California, which has the highest population of illegal immigrants of any other state. Second, the Hispanic population in the United States has a purchasing power worth $ 700 billion dollars and we believe that Bank of America is trying to stake out a part of this market before competitors capture this segment.

Bank of America’s new credit card program would be viewed under the Libertarian view of ethics as being unethical. First, while this new credit card program can be beneficial to both the illegal immigrants and to Bank of America, it could hurt everyone that uses the U.S retail banking system due to the fact that it does not hold the illegal immigrant or ID thieves to what they have charged to their credit cards. As a result, the immigrants could simply find a new identity to assume and would not have to pay their own debt.

Bank of America’s new plan would also be viewed as being unethical under act utilitarianism because instead of having the freedom to choose where their money goes, the illegal immigrants would have to keep a certain percentage of their money in their bank accounts. Rule utilitarianism would view Bank of America’s new credit card as being unethical, because it hurts the illegal immigrants from the get go by charging them excessively high interest rates in comparison to U.S. citizens. This hurts them in terms of equality and liberty.

April 23, 2007

The Lightest Shade of Truth: Earnings Manipulation at Krispy Kreme and Beyond

Each financial quarter, public companies are required by the SEC to publish their latest financial statements in accordance with GAAP (generally accepted accounting principals). At the bottom of their income statement, companies must calculate their most recent earnings on a per share basis. Months prior to earnings announcements, financial analysts from across the industry have already calculated an expected earnings per share for most public companies.

Usually, when companies announce higher earnings than expected their market stock prices immediately increase as a result of further anticipation that the company will continue to perform better than expected. On the flip side, when earnings are below what was expected their stock prices immediately reflect investors’ loss of confidence. When Whole Foods announced a once cent shortfall of earnings in the first quarter of 2006 their stock dropped 9.4% in one day; this is despite the fact Whole Foods reported a 26% increase in earnings and a 22% increase in sales from the prior year. As a consequence, some companies feel inclined to do whatever they can to artificially boost their earnings and keep their market value of equity from dropping. The Chamber of Commerce has recognized the incentives that companies have to “cook the books” to meet Wall Street expectations, and has begun to encourage public companies to refrain from issuing quarterly earnings guidance reports.

On May 25, 2004, The Wall Street Journal published the first story criticizing Krispy Kreme’s accounting practices. In 2003, Krispy Kreme purchased a struggling seven-store Michigan franchise. As a stipulation of the deal, the franchise owner would pay Krispy Kreme the accrued interest on past due loans upon completion of the repurchase. The company recorded this as interest income, an immediate source of revenue; however, the company booked the purchase cost of the franchise as an intangible asset, which was not amortized.

Most franchise repurchases in the food and beverage industry take into account that most of the cost associated with repurchasing a franchise is associated with property, plant, and equipment. The standard practice for filing these is to amortize the cost of these assets over several years. These amortization costs are deducted from revenues and result in a lower net income for the period. Although Krispy Kreme reported earnings that failed to meet Wall Street expectations, without the amortization costs their reported net income was misleading and inaccurate.

Krispy Kreme kept investors in the dark about other things as well. The failing franchise owner was allowed to remain employed at the company after the deal, but shortly after, that executive left and was paid an additional $5 million in severance pay. Krispy Kreme also recorded this expense in the unamortized asset category as reacquired franchise rights. The New York Times reported that, “these failures led or contributed to accounting errors – substantially all of which had the effect of increasing EPS (earning per share).”

On January 4, 2005, after starkly denying any wrongdoing, the Krispy Kreme board of directors announced that the company’s previously-issued financial statements for the fiscal year ended February 2004 would be restated to “correct certain errors”. The board determined that the adjustment to be made, which principally related to the company’s accounting for the acquisitions of certain franchisees, would reduce pre-tax income for 2004 by $6.2 million to $8.1 million. The company will also restate its financials for the first and second quarters of 2005.

Krispy Kreme is not the first to mislead investors with accounting practices that inflate earnings, nor will they be the last. All managers of public companies should be aware that their responsibilities to shareholders are more than just an ever increasing share value. Managers are also responsible for giving investors the most accurate picture of their companies’ financial health. Despite the consequences for reporting earnings below analyst expectations, it is not only the right thing to do but it also is the best for the company. It’s probably reasonable to assume that Krispy Kreme would rather have taken a 10% loss like Whole Foods for reporting low earnings, than the 80% market value loss and the negative attention that they received for their accounting practices. In this case, it may be better to be conservative in accounting practices than risk misleading investors and triggering an investigation by the SEC.

Although companies are responsible for their accounting practices and decisions, perhaps there is also a flaw in the system as suggested by the Chamber of Commerce. Analysts estimate earnings expectations in order to aid investors in analyzing the financial health of the company, but these estimates are estimates and offer room for error and interpretation. These expectations also provide companies with an incentive to manage their books since there are obvious repercussions for failing to meet market expectations. Whole Foods was punished by investors despite sales and earnings growth that most companies would be proud of. Krispy Kreme and others have collapsed under pressure in order to meet Wall Streets expectations. Are these expected earnings estimates creating more harm to investors though inaccuracy and incentives to shade the truth than they are creating a tool that investors can use to make wise decisions? Perhaps it’s best that investors do their own digging into financial statements and not Wall Street analysts.

April 7, 2007

Consequences and Implications of Corporate Gift Policies: Wal-Mart fires Julie Roehm

Julie Roehm, a high profile advertising executive, was terminated from Wal-Mart after only ten months with the company on accusations of fiduciary misconduct and violation of clearly established corporate ethical standards. She brought suit against Wal-Mart shortly after her dismissal claiming she was wrongfully terminated. Among other tasks, Roehm was in charge of heading up the search for a new marketing agency to take on the $580 million Wal-Mart account. During the process, Wal-Mart claims Roehm violated its strict no gift policy by accepting gifts and acting in a disloyal manner in order to give the advertisement agency, Draft FCB, an advantage in the competition.

Although Roehm admits to accepting gifts, including a case of vodka and a Toy watch, she claims to have reimbursed ad agencies, or requested that her account be billed for the full value of the items she received. Wal-Mart allows for social engagements combined with presentations to be part of the search process, but insists on paying the bill for the Wal-Mart executives in attendance. One extravagant dinner attended by Roehm, however, did not appear to be part of Wal-Mart’s approved review process and therefore it is unclear whether Roehm was billed. While some may argue that Roehm made an ethical attempt at compromise while conducting amiable business, Roehm appears to have violated Wal-Mart’s strict gift and gratuity policy and thus, even if she was clean on all other accounts, Wal-Mart had a valid basis on which to terminate her.

Examining this case in terms of alternate gift policies, we conclude that there would have still been grounds for Roehm’s dismissal. If Wal-Mart had a policy with a maximum value allowed, it appears that the dinner in question was worth much more than the standard $100 limit, and so still may have been unacceptable. Using a post-transaction policy for gifts, we see that Roehm attended the dinner with advertising candidate Draft FCB a month before an ad agency was chosen by Wal-Mart, and therefore would not have been able to consider it a “thank you” gift.

Is Wal-Mart’s staunch no gift policy too strict? In this case, it appears that Wal-Mart cited the gift violation as terms for dismissal in lieu of publicizing more personally harmful accusations about Roehm. But now that the case has escalated, more than sufficient evidence on multiple issues supporting Wal-Mart’s decision has come to light on its counter-claim. It's possible that Wal-Mart’s gift and gratuity policy, although consistently applied in this case, may provide grounds for unnecessary dismissal of otherwise ethical employees if taken to the extreme. Certainly the company would not want to be in the position of firing a conscientious committed executive for accepting a cup of coffee or a free pen from a vendor or client.

To avoid this dilemma, we propose that Wal-Mart consider taking the following actions:

1. Evaluate its hiring practices to ensure it adequately examines candidates’ ethical standards and personal virtue as part of the hiring process.

2. Make a conscious effort to instill loyalty in employees so as to increase their desire to act in the best interest of the company.

3. Adjust its gift policy to allow small gifts under a certain value to be accepted and presented in the course of professional interaction, while still requiring larger gifts to be reimbursed.

These actions may be applied in varying degrees to executives only, or to the entire employee base, as Wal-Mart sees fit. The purpose for additional steps in hiring practices ties to Aristotle’s view of virtue; that people who are ethical and possess personal virtue will act most consistently in that manner, while people lacking virtue are not likely to attain those characteristics simply because of a company policy. We feel the good will and trust that the latter two actions would evoke would create a better atmosphere for business interaction and a better relationship between Wal-Mart and its top employees.