Taking the Fall
Upstart Kiwi International Air Lines once soared on the happy illusion that employee owners ran the company -- and when the airline took a dive, employee ownership got the blame. Are there lessons in Kiwi's travail? Yes, but they're not the ones its founding CEO is peddling
If this decade's most widely acclaimed experiment in employee ownership ultimately fails, there will be a simple explanation for it.
Bob Iverson, the former and founding CEO of Kiwi International Air Lines, has already told anyone who will listen where to lay the blame for the tide of red ink that threatens to drown the three-year-old venture. "One of the stupidest things I ever did was call everybody owners," a rueful Iverson told the New York Times in an interview last March. Employee owners were insubordinate and meddling, he alleged. Decision making was belabored, financial discipline impossible. Iverson has even written a book recounting the perils of employee ownership, called Kiwi International Air Lines: An ESOP Fable.
The real fable is the one that makes Kiwi, based in Newark, N.J., out to have anything resembling an employee stock ownership plan (which it does not) or to be anything but a bizarre caricature of egalitarian management. While it is a fact that Kiwi is owned by its employees and that right now the airline could use a flotation device made of cash, the ownership structure is not the problem at Kiwi -- where employees are perhaps the most powerless "owners" ever created by a certificate of stock.
Rising on a gust of righteous rage over the way airline managers had mistreated them, Iverson and the other unemployed survivors of Eastern Airlines and Pan Am rejected the caste system of traditional management. When they founded Kiwi, in 1992, they envisioned a company of equals that would be happily, communally owned.
"It was the dream of unemployed people coming together, pooling their money, and starting their own company," says Jack Tucker, a company spokesman. "Kiwi was the American dream, really."
Not for long. Hardly a crisis has spared Kiwi, which serves seven cities and employs 1,100. According to unaudited Securities and Exchange Commission filings, the airline lost $24 million last year on revenues of $114 million, pushing its cumulative operating losses to nearly $40 million. To keep the company afloat past this year's third quarter, an infusion of at least $15 million is desperately needed. And in recent months Kiwi has stopped or rescheduled payments on at least $6 million in debt. In addition to unpaid creditors, it has a $3-million problem with the Internal Revenue Service -- the result of unpaid excise taxes. The Federal Aviation Administration has been closely policing Kiwi ever since it temporarily grounded the airline for training infractions last December. Three chief executives, including Iverson, were fired in a six-month period this year. At press time, the search was on for a fourth. Stock sales to employees have been "temporarily suspended," according to Tucker. And Arthur Andersen, the company's auditor, expressed in its most recent auditor's report "substantial doubt about the company's ability to continue as a going concern."
In Kiwi's tale of woe lies a truth about employee-owned companies. But it's not, as Iverson contends, that they simply don't work.
Why, then, is Kiwi, which Consumer Reports ranked in June as the nation's third-best airline, on the brink of bankruptcy? The answer goes back to its founders, who built the business on a single article of faith: there would be no management elite at Kiwi, no coach and first class. It was a worthy principle -- and a poisonous practice.* * *
Buying revenge, share by share
Employees, who hold 53% of the company, invested anywhere from a few thousand dollars to more than $50,000 each, providing just a little more than $9 million of $17 million in paid-in capital. People tapped savings or dunned paychecks to finance the upstart airline. "There were guys I flew with at Eastern who were driving limos," says pilot Fran McBride. "We were just a lot of guys anxious to get back into the cockpit."
Nearly everybody at Kiwi felt that way. "No other carrier welcomes 20-year captains as captains," says Iverson, a former pilot. At Kiwi they'd trade in their customary six-figure salaries but keep their stripes.
Raising lots of small investments from lots of individual investors was as systematic as selling raffle tickets. The odds of winning, in an industry littered with bankrupt upstarts, were lottery-long. But hundreds bought a chance. They bought a chance at resurrecting careers cut short. They bought a chance at proving something to all the arrogant suits in airline management, who viewed veteran employees as a cost to be renegotiated at contract time, and who thought of pilots as glorified bus drivers.
Ramp-services manager Doug Davis and his wife, Deb, a Kiwi flight attendant, scraped together their $10,000 share after being unemployed for almost two years during the Eastern strike and liquidation. McBride remortgaged his home and borrowed against his retirement savings to come up with $50,000. "Hey -- thanks a million, I can make another mortgage payment," he likes to tell passengers as they depart. In addition to the equity that hundreds of employees ponied up, 28 pilots later lent another $1.2 million in unsecured debt.
These financiers were former strikers seeking a more perfect union -- of labor and capital -- not for the sake of some socialist ideal but for a steady paycheck. It was a marriage of necessity: Kiwi had to be employee owned, for the simple reason that "no one else would give us a dime," Iverson admits. The capital markets rejected the idea that cheap labor and plentiful equipment were enough to keep a new airline aloft. So Kiwi's employees became investors of last resort, buying jobs from an employer of last resort. The company got capital cheap. A per-share price of $5 was generous. And arbitrary, according to Iverson. Employee shareholders paid up front and, in most cases, in cash. Pilots anted up $50,000 apiece, everyone else $5,000. Until February of this year, they did so as a condition of employment. And they did so without the protection and rights that most of the 10 million employee owners in this country claim as shareholders.
Kiwi has no ESOP. It never played by the rules of a qualified employee stock ownership plan -- which mandate regular reporting to shareholders and regulators, and which Iverson says were "too burdensome."
While most ESOPs grant stock at no cost to employees -- and set up a separate trust to borrow money and pay the seller for that stock -- Kiwi billed shareholders individually. Even when ESOPs exact an employee contribution, they usually ensure that workers pay in pretax dollars. Kiwi took their money after taxes. In ESOPs, shares are valued according to an independent appraiser's estimate of their worth. There was no oversight to the pricing at Kiwi. Federal law requires that ESOPs allow employees to cash out by buying back their shares. Kiwi made no such promises. In fact, a senior lender has prohibited the company from repurchasing stock, making the employees who bankrolled Kiwi utterly captive investors.
The company, however, benefited enormously from the joint-ownership deal with employees, reaping lower labor costs and fawning press. Kiwi's newly certified owners turned from their union ways. Pilots earned a third as much as their counterparts at United, Delta, or American command. Even Iverson made a mere five figures.
No work rules hindered their volunteer spirit: Pilots pitched in to clean airplanes on tight turnarounds. Flight attendants bought flowers for the planes' bathrooms and served gourmet meals. Nobody tossed peanuts.
Passengers, in stunned gratitude, wrote phrases like "God bless you" on their comment cards. In 1994 Kiwi was voted best domestic carrier by CondÉ Nast Traveler.
"The same people that Frank Lorenzo [who seized Eastern Airlines in 1989] said were a problem went out and built the best airline in America," says pilot Andy Sapol. For these former employees of the industry's dead or dying, Kiwi's rambunctious growth from zero to $114 million in less than three years was the sweetest revenge for the jobs they'd lost and the airlines they'd buried.* * *
Anything but professional
Although Iverson and his four founding partners were handing out stock as quickly as they could persuade employees to pay for it, they were not handing over control. The shares employees bought carried no voting rights, which means that employee shareholders at Kiwi can't so much as rubber-stamp a board decision, much less override one.
Voting rights were instead pledged to a voting trust that will reign until 1997. Originally composed of Kiwi's five founders and still made up of insiders, the trust is run by a junto of pilots who appointed themselves to five-year terms. The trust, in turn, controls the board. "The voting trust was designed to be all-powerful," says lawyer Martin Hauptman, who set up the voting trust and drafted Kiwi's corporate bylaws. "Ostensibly, it was tailored to maintain control of the company in the face of an external takeover threat. But it was also drafted to prevent employee shareholders from exercising any rights."
It's not unusual, even in majority ESOPs, for management to appoint a trustee to vote for the employee shares, according to Corey Rosen, director of the National Center for Employee Ownership, in Oakland, Calif. "But I don't know of any case in which employees purchased shares outright and did not get voting rights," he says.
Now that the airline is on the ropes, the shareholders have almost no recourse for changing the direction of the company or the composition of its management. Nor can they remove the trustees who call every shot, clear of shareholder proxies.
According to the trust's bylaws, a trustee can be removed only if a majority of the remaining trustees vote to dismiss him from both the trust and the board. That technicality, which protects the trust from outside assaults, is what put Iverson, the founding CEO, in jeopardy. When Iverson was escorted from the company's headquarters in a humiliating exit in February, a 4-member minority of the 12-member board had engineered it.
Whether the ouster was prompted, as the trustees allege, by Iverson's inadequate leadership or whether it was the result, as Iverson charges, of personal rivalries, the trust used its extraordinary power to conduct a secretive purge without a vote by the board or the shareholders.
They had staged a coup in a company that billed itself as the ultimate democracy.
Collectively, the trustees hold less than 5% of Kiwi's stock, but the trust ensures they will control more than 50% of it. The trust itself cannot be abrogated without the unanimous consent of all shareholders. And since at least a handful of those shareholders have an interest in maintaining their positions as trustees, unanimity is unlikely.
Why did employees put up the bulk of the money and agree to forfeit almost all control?
"We felt a tremendous debt of gratitude to the people who put this airline together, who gave us our careers back," says pilot Sapol. Besides, the managers of Kiwi weren't really management: they were brother pilots. The companywide distrust of professional management ran deep; it was the legacy of workers' defeat at the hands of Frank Lorenzo, whose ghost still haunts the airline's survivors nearly seven years after Eastern folded. "Control was very important to us," says recently ousted chairman John Anderson.
Control was so crucial and paranoia so powerful that the voting trust stacked the board with like-minded pilots, not practiced managers, and awarded vice-presidencies in strategic planning and human resources to individuals who had never performed those functions at another airline. The CEO himself had never managed so much as a baggage carousel.
Only one of the original directors had been an airline manager. "Even when employee owners do call the shots about who should run a company, they usually hire managers who look like the top management at other companies," says Rosen, the employee-ownership expert. "Most of the time, they're not looking for somebody just like them. They're looking for somebody who knows how to make them some money."
Kiwi's employee owners never got that chance.* * *
A broken chain of command
"We started out with an idealistic, egalitarian notion about how the company could be run," recalls Iverson. "We had been steamrolled by management in the past, so we wanted to create a management structure that was very horizontal, very team oriented."
The result: the trustees, all of them initially carrying titles of vice-president, failed to devise a clear chain of command among themselves or other top executives. The management, which would swell to 11 vice-presidents, behaved like a confederation of feudal lords, resisting centralized government.
Iverson kept the titles of chairman, CEO, and president, a presumption that clearly rankled his cofounders, but he grew increasingly politically weak. The more he tried to impose a conventional management structure, he says, the more unpopular he became among the pilots who sat on the board and controlled the trust.
"The VPs all operated under the presumption that orders were suggestions," says Iverson. "They undermined the notion that any one person should be a leader."
Replies former chairman John Anderson: "We didn't have a leader in Bob Iverson. He never showed himself capable of running this airline profitably."
Iverson says he had neither the authority nor the political capital to sway managers in crucial matters. His hiring decisions were ignored or overturned, he says. His equity deals, including one earlier this year that he claims would have brought in $7.5 million for 51% of the airline (with an option to buy back control) and weakened the voting trust, were rebuffed. The deal would have diluted shareholders' stakes, but industry analysts such as Cameron Burr, managing partner of Burr Associates, an aviation advisory firm, predict that dilution is inevitable for shareholders whose equity now has a negative value of $21 million.
Iverson's attempts to discontinue unprofitable service to San Juan, Puerto Rico, were resisted. His orders to match competitor Continental Airline's fares were subverted, he maintains. His efforts to augment revenues with charter service were sabotaged, he says. Over time Iverson's ability to manage his officers' dissent eroded.
"Sometimes he'd have 11 people yapping at him," reports one insider. "And he'd throw up his hands and walk out." Iverson didn't exactly endear himself to the three members of the trust whom he attempted to demote or fire. He "had a tendency to throw gasoline on fires," says another insider. Iverson contends that his comrades, who believed their power should be equal, resented his getting too much authority.
The consequences of Kiwi's politburo approach to management and Iverson's failure to master or change it were far-reaching and grave. "Kiwi was too distracted with internal affairs to address external threats quickly," says Joe McCune, a consultant who in 1994 advised the company to pare its management structure. Filibustering and dissent made decisions about routes, fares, leases, advertising campaigns, and equity deals impossible. "We ran the company like a little pilots' union or a flying club," Iverson says, "not like a business."* * *
Ugly and hidden from view
Despite Kiwi's communal ownership, the company's books were slammed closed. Before coming aboard, employee shareholders received no financial projections. Afterward they got no statements of actual financial results. Until this year, Kiwi had never held a formal annual meeting.
Even outside investors got scant information about the airline's worsening condition. "Getting regular financial statements was a problem," says Norman Waltuch, an investor and outside director.
McBride, the pilot, notes that "Iverson might mention a good month. But no one ever told us when we had a bad month." And Kiwi, which reported profits in only two quarters during its first two and a half years, was having a lot of bad months.
The absence of centralized budgeting or purchasing hampered financial control. It took weeks to produce monthly financial statements. Taxes and fees went unpaid. Costs -- at least the ones that Kiwi managed to track -- escalated, sometimes three times faster than sales.
Employees had no clue. Perhaps if Kiwi had disclosed the ugly numbers, employees might not have bridled at cost-cutting measures that appeared to come out of nowhere. Flight attendants, who resisted a move to end hot meals on certain flights, never knew that food-service costs at Kiwi far exceeded industry averages. They never knew the airline had come dangerously close to missing payroll -- until they were asked to take pay cuts at the end of last year.
"We were sort of in the dark about a lot of things," says pilot Andy Sapol. So were the department heads. Unguided by the numbers and unchecked by any budgets, they might as well have been wearing blindfolds.* * *
Fiercely Loyal but badly served
From day one, the antimanagement coterie who ran Kiwi made sure that nothing would interfere with their exercise of power. Because of their fear that bogeyman Frank Lorenzo -- or someone like him -- might return, they set up a system that concentrated power in the hands of a few well-meaning novices. As Kiwi struggled to stay aloft, the voting trust moved to install more seasoned managers. But it refused to cede control. In the corner office, musical chairs ensued.
Russell Thayer, a 42-year airline veteran and until July an outside director, currently serves as chairman. After Iverson was toppled, in February, Byron Hogue, a former executive at Federal Express Corp., was named as his successor. He resigned less than three months later. In May the company trumpeted Danny Wright as the savior who would bring stable management to Kiwi as its new CEO. Wright, who had been a consultant to Kiwi, lasted two months in the job. "The board didn't feel that Danny had the background to move the airline forward," says Robert Marcus, a Kiwi spokesman.
Others had reached that conclusion much sooner. "Where [then-chairman] John Anderson found Danny Wright, I don't know," says Charles Stanziale, general counsel for Kiwi and a former outside director. "It's not like he came from American or Southwest or Delta."
While Wright and Anderson insist that the selection of Wright followed an exhaustive search, Stanziale and other former insiders say no formal search occurred. Members of the voting trust, they contend, simply installed Wright by fiat. "There wasn't a lot of time to check his background out," says Stanziale. Wright, however, claims he underwent the most extensive background check of his career.
Ironically, the latest CEO to decamp the employee-owned company was neither a shareholder nor an employee. A hired gun, Wright collected $600,000 in five months, according to Stanziale. Iverson had been paid one-tenth of that amount in a year.
"We need good airline management," says Thayer. "We're looking outside to fill the top positions in the company with seasoned management." Despite the constant changes in management, "this company could pull it out," says former financial adviser Jim Harris, owner of Seneca Financial, in Greenwich, Conn., who worked with Kiwi until April. "This airline has incredible worker loyalty and passenger loyalty. But all management has done is take away every opportunity for this thing to work out right."
Indeed, employee ownership has not failed Kiwi. Management has.
Kiwi's founders believed that employee ownership would protect their jobs and prevent bad management. They considered management a cynical exercise of power, not the necessary application of skill. But like every company, Kiwi badly needed leaders who were separated from their workers -- but by their managerial skill, not by venal hearts or the will to power.
"The managers at Eastern," reflects Doug Davis, the ramp-services manager, "were more concerned with their own agendas than with running an airline business." Davis hangs on to the hope that it could never happen at Kiwi.
And hope, despite everything, is what continues to drive these employee owners, most of whom don't have the power or privilege of ownership. Only the hope. But companies don't survive on hope. They don't survive on the dedication of workers or the enthusiasm of customers, although that goodwill goes a long way. They survive on the competence of their management, acting in concert with the market and in the interest of the owners, whoever they may be.
"A lot of people have put their emotional and economic lives on the line for Kiwi," says Harris, "and they're not being well served."
Not that employees, even when they call themselves owners, expect all that much. They expect to own their jobs. And even though their shares are, by the balance sheet's reckoning, worthless, many continue to pay for them out of payroll deductions. They won't let go of their piece of the sky.
"When I'm cruising at 30,000 feet, I look around me sometimes and I think, 'My God, this was almost taken away," says McBride. "Thank God, I got it back."* * *