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ANALYSIS OF DRAFT CONSTITUTION NEW INDUSTRY GOOD ORGANISATION - MEAT + WOOL BOARDS

By Tony Baldwin - www.baldwin.org.nz

PRELIMINARY COMMENTS

This report focuses on four main issues:

1. The choice of corporate form for the new organisation;

2. The meaning of ‘industry good’ and how it is applied in this case;

3. The proposed ownership structure, with particular focus on with the way owners’ rights have been fragmented; and

4. The proposed board structure, in particular the reservation of two positions for meat processors and exporters.

In the course of reviewing the draft constitution, I have come across a range of technical issues which can be divided into two groups: the first is a set of drafting concerns that could have a significant impact on governance; the second is a set of minor drafting points which may be of assistance to the people preparing the constitution. I will write these up and forward them if you request them.

CHOICE OF ORGANISATIONAL FORM

The Commodities Levies Act 1990 does not prescribe the corporate form a levying raising organisation must have. Any body corporate may levy if it satisfies the statutory requirements relating to how the levy is raised and how it is used.

Given that commodity levies cannot be used for commercial purposes, organisations raising levies are ordinarily incorporated societies or bodies of a similar character where the primary aim is not to increase the value of members’ capital.

The company form is normally used where an organisation’s primary goal is to aggregate capital and take business risks with a view to increasing the value of the members’ capital.

It is therefore curious that the Meat and Wool Boards are proposing to incorporate their new industry body under the Companies Act 1993. There could be three reasons for this:

· The new body is to have dual purposes: part ‘industry good’, part commercial;

· A company may be viewed by its promoters as having a better brand. In short, it sounds better, more business-like; and/or

· Establishing a company may be a way of retaining accumulated tax losses in businesses which are to be transferred to the new body.

I would surmise the promoters’ rationale is a combination of all three, so I offer a brief comment on each consideration.

The choice of corporate form should not be driven by tax issues. If these are material, there are likely to be other, less distorting ways of protecting tax losses.

Nor should the choice of corporate form be driven by branding. A company may sound more business-like compared to an incorporated society, but this connotation can be achieved by other means (such as efficient performance) which avoid the complexities associated with trying to adapt the profit-orientated features of a company to the non-profit orientated objects of an industry good body. As noted below, the draft constitution is strained in trying to achieve this adaptation.

The new body’s promoters are likely to see it as having dual objectives: ‘industry good’ and commercial. This is clear from the mixture of Principal Activities in clause 1 of the draft constitution (discussed further below). It is also clear from the range of other investments the new organisation is intended to hold, such as Ovita.

Dual objectives create a major problem, for at least two key reasons:

· Organisations with competing objectives tend not be successful. Dual objectives create confusion and ambiguity. It is now well established in modern corporate governance that successful organisations have a clear and single primary goal.

· An organisation with dual roles – one, seeking to earn profits and grow wealth; the other, spending compulsory levies on ‘industry goods’ – has both the means and the incentives to ‘mix’ each function. It is inevitably very difficult to ensure a clean separation of receipts and expenditures, costs and revenues, between the two sets of activities. The risks of ‘blurring’, with its resulting erosion of accountability and performance, are high.

Recommendation 1

Establish separate entities: a company for commercial activities, an incorporated society for ‘industry good’ activities.

DEFINITION OF ‘INDUSTRY GOOD’

Concept

This is a pivotal definition. Before focusing on detailed wording, consider the underlying concept. It is simple but widely misunderstood.

For many years, an ‘industry good’ has been viewed in both the meat and wool sectors as ‘something good for the industry agreed by wise men acting with the greater interests of the industry at heart’. Supported by a statutory power to levy without requiring a vote of levy payers, the relevant producer boards have each developed a large body of activities which they view as falling within this broad notion of ‘industry good’.

In truth, ‘industry good’ is a much narrower concept. Not surprisingly, many industry leaders try to refute or avoid it. But its key elements are not in dispute. An ‘industry good’ is an activity where:

· Total benefits are reasonably likely to be greater than total costs; and

· The people willing to invest voluntarily cannot capture enough of the benefits to cover their share of the total costs. This is often because the spread of benefits cannot be easily confined.

The normal policy and business response is to look for ways to control the flow benefits. Patents, trade marks, copyrights, contracts and physical restrictions on access to assets are all examples.

Free-Rider Test

The fact that ‘free riding’ occurs does not mean the activity is necessarily an ‘industry good’. ‘Free riding’ occurs in many commercial activities (for example, large amounts of intellectual property spill to competitors and consumers who do not pay). The existence of ‘free riders’ is therefore not the key.

What counts is whether those willing to invest voluntarily can capture enough of the benefits to cover their share of the costs. It does not matter if they cannot capture all the benefits.

If they are able to corner enough benefits to provide an adequate return on their investment, the project is likely to proceed. If not, it probably will not and, without Government intervention, the economy would miss out on the net benefits the project was expected to generate.

The power to levy is therefore provided by the Government to counter this problem. Rather than seeking to restrict the flow of benefits, a levy forces everyone able to receive benefits to contribute to the activity’s costs.

Reliance on Levies Test

It follows that ‘industry goods’ are ordinarily funded from compulsory levies. If the activity would otherwise occur using voluntary non-government funding, it is not likely to be an ‘industry good’. Funding of an ‘industry good’ by private individuals or private organisations may occur, but it is rare given that such funding is, in effect, an act of private charity – a field in which donors tend to focus on other areas of public need.

A fundamental error is therefore evident in clause 1.2 of the draft constitution, which states that a principal activity of the new organisation is:

“raising money to fund Industry Good Activities from such sources as the Board thinks appropriate, including:

b) investment by private organisations; c) exploitation of intellectual property owned by the Comp



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