A REPORT ON INSTITUTIONAL INVESTORS AND THE HERMES FUND MANAGEMENT IN REGARD TO TOTAL AND PREMIER OIL.
INTRODUCTION AND EXECUTIVE SUMMARY
Institutional investors may be defined as functional financial investors such as pension funds, insurance companies and mutual funds, preceding a specific objective in terms of acceptable risk, return maximization and maturity of claims (Davis and Steil, 2001 ). Institutional investors have been seen by commentators as potential monitors of management due to the engagement of corporate governance activities, in other words they play a very vital and effective role in contemporary corporate governance.
A study carried out by the California Public Employees' Retirement System (CALPERS)
finds a positive stock price reaction when a firm takes on changes.
This report discusses the role of an institutional investor in influencing the strategy of a company in which it invests, using the Hermes/Total's activities in Burma/Myanmar relationship as a case study. It is presumed that institutional investors operate an efficient market capital which improves market efficiency (Davis and Steil, 2001 ).
Institutional Investors are a permanent feature of the financial landscape, and their growth would continue at a similar and perhaps faster pace. The factors that underpin their development are far from transitory and in many cases have only just started having an impact. Therefore the behavioral characteristics of investors would be an increasing determinant of domestic and international financial market conditions. The implication of financial market stability warrants serious consideration (Bank for International Settlement Annual Report,1998).
They are a major force in many capital markets due to the large investments made by the fund management industry directly under their clients name. Most institutional investors are not remembered on the basis of the performance of portfolio companies, but on the basis of the volume of assets under management. Fund performance is reviewed by the institutional investors because it favors the increased size of assets. Most companies want institutional investors influence in areas of information supply, especially in particular business development, transparency in accounting and risk management (Strum, 2009).
In order to fulfill corporate governance issues whilst also maximizing return on investment in Burma/Myanmar, a recommendation against disinvestment has been made using suitability, acceptability and feasibility framework. For goal congruence, it is important for Hermes and Total oil to work together towards improving corporate governance issues in a bid to remain in the area.
CORPORATE GOVERNANCE
Over the last four decades, a competing prototype of shareholders democracy has developed. These days shareholders ask increasingly for an input on decisions that would have remained in the purview of the board's management's business judgment (Watkins, 2012). The improvement of corporate governance is a popular trend throughout the world by different countries. To help investors evaluate a firm's corporate governance, a number of independent rating services have established criteria for good governance. Corporations are primarily governed by the board of directors supervising/managing top management in sync with the shareholders.
The term corporate governance refers to the relationship among these three groups in determining the direction and performance of the corporation. Different corporations have been anxious that various requirements to enhance corporate governance will hold back top company management. Institutional investors are now more active on boards in putting more pressure on the management for the improvement of corporate performance (Wheelen and Hunger, 1999).
Corporate governance has succeeded a great number of interests due to its importance for the economic health of corporations and society in general. Criticism of corporate government is back with a vengeance in the post-Enron era. Governance reform has been a hot topic since the 1980's, firms in America faced increased globalization and change, boards were said to be manipulated by their chief executives (www.studymode.com).Companies are becoming more involved with corporate governance and following more guidelines. Corporate governance ensures investors get an appropriate return of their money.
CORPORATE SOCIAL RESPONSIBILITY
Corporations are primarily business organizations run for the benefit of shareholders having a wide range set of responsibilities to owned employees, customers, suppliers and the communities in which they are located in and to the society at large. Corporations do not always succeed in achieving the responsibilities they support. Corporate Social Responsibility (CSR) concept originated in the 1950's when the American corporations rapidly increased in size and power. The European commission puts two definitions of CSR as one, saying "companies deciding voluntarily to contribute to a better society and a cleaner environment where by companies incorporate social and environmental concerns in their business operations and their interaction with their stakeholders on a voluntary basis" (www.mallenbaker.net). There are many approaches by which companies can implement CSR.
Implementing community development projects
Provide education facilities
Building infrastructure in the local area
Make eco-friendly products
Provide health care facilities to the region
Support environment savior movements
Empower use of environment friendly products in to company
Since most of the international standards concerned with corporate service
responsibility issues are implemented on a voluntary basis, CSR can also be a form of self-regulating and implementing sustainable and responsible business (Nordmann, 2012).
Former Unilever CEO, Nail Fitzgerald expressed his support saying "corporate social responsibility is a hard-edged business decision, not because people are forcing us to do it, but because it is good for our business (Riley,2012).
INFLUENCE OF INSTITUTIONAL INVESTORS
'exit and voice' framework, arguing that dissatisfaction may be expressed directly to management (voice option) or by selling the shareholding (exit option).
The Cadbury committee (1992) saw institutional investors as having a definite accountability of ensuring recommendations being adopted by companies, declaring that 'we look to the institutions in particular in order for their influence to be used as owners make secure the companies they have invested in accede with the code. The Greenbury report (1995) also held such a view which they said the institutional investors should use their power to influence the use of best practice as set out in the UK governance code.The Hampel report (1998) also stated how clear the role of shareholders in corporate governance concerns the institutions. The large and influential institutional investor in the UK, Hermes in 2002 issued its principles, stating that companies should seek an honest, open and ongoing converse with shareholders (Mallin, 2007) and (Useem, 1996),stated the rise of investor capitalism in the USA and described how the concentration of shares and power in to a relatively small number of hands, has enabled institutional investors to challenge management directly on issues of concern.
Institutional investor are seen as having a particular role to play in the corporate governance of their investee companies and so they are increasingly encouraged to be more active in approaches and should also try to certify the 'hidden value' is released where possible (Millin,2006). Institutional shareholders normally monitor their holdings by using a screening system based on financial performance such as benchmarks, problem areas and concerns and determining causes and effects of the problems. Though they normally do not micromanage their investments, they ensure that the investee company is well managed and has a very clear strategy.
Intervention does not regularly happen except in very rare circumstances like the concerns about strategy, operational performance, mergers and acquisitions, inadequate succession, planning and non-compliance with corporate governance reform. The institutional investors may by having additional meetings with management express concerns through the company's advisors, meet with the independent directors, lead directors or the chairperson of the board.
Others are collaborating with other institutions on intervening activities, making a public statement in advance of annual shareholders meetings, requesting an additional meeting in order to change the company's board, meeting with board committees like the audit, compensation, nominating/governance (Rezaee, 2008). The institutional investors that directly manage investments have greater ability to act upon their concern regarding human resource management than benefit funds that outsource the management of investors (Mitchell et al, 2011 ). In most cases, the institutional investor earns its revenue as a flat percentage of its assets under management and it creates an incentive favoring rapid fund growth (OECD, 2011 ).
SCOPE OF HERMES FUND MANAGEMENT
The focus funds Hermes is involved in, looks for companies whose performance raises concerns like a falling share price and questionable strategic actions. The concerns might come from a Hermes analyst or from the brokerage community. Hermes usually does not get involved with the worst companies because they do not want to lose their clients money. Hermes tends to invest in strong companies with boards that are open minded enough to accept change. The companies Hermes picks are often very strong, but have particular issues that Hermes feel they can resolve (Coombes, 2004).
Hermes is the principal manager for BT pension scheme and it manages investment on behalf of other pension plans. It is also one of the few pension funds not owned by a bank or any large financial institution, Hermes believes it offers a service which does not bring conflicts like other large financial institutions experience. The only fund manager to have documented what it requires from companies is Hermes, in a document known as 'The Hermes principles' and this document can be downloaded from www.hermes.co.uk/pdf/corporategovernance/HermesPrinciples.pdf.
Hermes approach follows an observation of business managers who do not influence performances of companies. It looks for professionals who are active, ensuring the board has the right enterprise, independence and expertise in order to increase company's value.
The negative side of this belief is that shareholders can create chaos, especially given that most companies have thousands of shareholders. Even at this, Hermes has remained successful in its involvement in using votes to approve board of directors and also its intervention to companies failing to solve essential problems. In Hermes experience, strategic and capital structure failures rarely occurred at companies where the board is functioning well, and the presence of solid bodies. Truly independent non executive directors focus on Hermes involvement with its investee companies on board structure.
Hermes' intervention in the case of Premier Oil was how appropriate it was for a non• executive director to represent the interests of particular shareholders (Johnson, 2005). Premier oil's major problem was that it was dominated by two major shareholders Amerada Hess, a US company and PETRONAS a Malaysian national oil company each of which held 25 percent of the shares. Premier oil also had a management problem; it was not large enough to compete in production and downstream work with upcoming super major oil companies. However, there were positive works too, like building schools, funding teachers and providing AIDS education.
Premier's under performance was due to their lack of a clear strategy which was very different from Total. Some social groups have raised ethical concern about the operation of Premier oil in Burma and therefore approached Hermes as an institutional investor in the company to dissuade them from further investment.
Hermes took some actions regarding Premier oil by holding regular discussions with interested investors, the Burma Campaign UK, UK governments and other parastatals. There was a direct flow of communication between the chairman who was open to improve the board system by first adding new independent NED's and discussing strategic and ethical concerns of premier oil.
The Hermes engagement led to a restructuring process and a tradeoff to 'swap assets for shares' which freed up cash and led to the cancellation of the 25% shareholdings all of which was backed by shareholders due to how valuable the approach was.
Hermes' intervention led to the doubling of Premier oil share price and their withdrawal from Burma, it also resulted in an excess return to Hermes' clients. In David's view,
'Premier oil became established as a strong independent E&P company with a real
opportunity to continue to add value for its shareholders.' (Pitt-Watson and Johnson;
2010).
SHOULD HERMES SEEK TO INFLUENCE TOTAL WITH REGARD TO THEIR ACTIVITIES IN BURMA/MYANMAR?
There are strong social and commercial disincentives for new investments in weak states with a history of political violence (Bannon and Collier, 2003) as in the case of Burma/Myanmar.
Total had a bad reputation for corporate responsibility due to its previous environmental records. Hermes had to visit Total's operation in Burma/Myanmar as an invitation from shareholders. Hermes did not want to go to Burma because of the controversy and its history of military dictatorship. Once conflict breaks out it tends to make matters worse through its effect on the structure of the economy.
Total had two strategies: Operating in troubled regions and access to exploiting oil and gas reserves in mostly Organization for Economic Co-operation and Development (OECD) countries. OECD countries help natural resource dependent, low-income countries to diversify by removing tariff and non tariff barriers on value added goods (Bannon and Collier, 2003) .Total was still in Burma in regards to the poor government due to the financial risk in case there was a change of regime or sanction compelled by the UN or the EU.
However, its mode of business had a good financial performance and underlying government power. The project benefits the population as it is a significant source of funding for the junta in power. To shareholders the sole reason for starting or investing in a company is to make profit. If this was what Total was doing, then it was indeed a good business strategy. Founder and senior advisor of Hermes, David Pitt-Watson reflected on the engagement Hermes had with Premier Oil which he had help develop over ten years and on the positive response of the share price that had been a vindication of Hermes approach to fund management.
What are the possible solutions regarding Total? What are Hermes' rights and duties? Total was convinced that Hermes would be impressed due to their dealings with corporate social responsibility issues. The issues addressed with premier oil were significant governance, strategic and financial issues as well as social responsibility and corporate governance; this was not the case with Total. Total Oil is different from Premier Oil in the sense that Total was involved in a self-aggrandizing project which formed part of an excellent goal.
While Hermes was pressing for some governance improvement, Total alleviation work and transparency was not fully satisfying despite its operations being legal in its aim to contribute to social development in Burma/Myanmar.
RECOMMENDATION AND CONCLUSION
Institutional investors are becoming more important in global finance contributing to deeper and better functioning markets. With the growing importance of institutional investors, regulatory and accounting policy changes that affect pension funds and insurance companies can have vital implications implemented or completed across the world (CGFS papers, 2007). The main goal for return oriented investors is to increase the value of a portfolio over the long term (Staub-Bisang,2012). The superior role of long-term institutional investors suggest that institutional investors with a long-term investment horizon play a more valuable governance role in mitigating agency problems than investors with a short-term horizon (Attig et al,2011 ).
In making a recommendation to the board, it is important to consider how: suitable, acceptable and feasible it is to dis-invest from Burma/Myanmar.
Suitability:
This deals with the overall aim and strategy of the business which is to increase return on investment. Therefore, a balance between corporate social responsibility, corporate governance and return on investment has to be reached. A decision to dis-invest could mean shareholders lose out which defeats the purpose for which Hermes and Total oil exists that is; to maximize return on investment. As a result, it is not suitable to dis-invest as it does not strike the correct balance.
Acceptability:
If shareholders lose out they are likely to disagree with the decision. Also, CSR will not be fulfilled because the contribution to social development in Burma/Myanmar will be withdrawn leaving the community at a loss.
Moreover, in considering corporate governance issues it is important to consider cultural differences which may lead to a different approach in Burma/Myanmar. As a result, Total oil has dealt with it by using best practice.
Based on this, disinvestment is unacceptable to stakeholders at large.
Feasibility:
Feasibility is concerned with the financial viability of the possible decision to dis-invest based on a cost benefit analysis. As pointed out, it will be very costly and time consuming for shareholders to put pressure on the company especially if it is making profit. It has also made a competitive advantage of operating in regions seen to be troubled.
Therefore, it is not feasible to dis-invest due to possible negative financial impact.
Moreover, in making comparisons with premier oil, total oil is larger and the strategy that was employed by Hermes on premier oil is 8 years old which may not be implementable in the present environment as well as having a smaller shareholding presently.
Based on the issues pointed out above; a recommendation will be to stay with Hermes and Total coming together to improve corporate governance issues. The shareholders invited Hermes to visit total operations in Burma/Myanmar which indicates an improvement on is needed.
A positive reaction is reported in a study, when corporations settle on governance proposals made by the united shareholders association, the author estimated in both studies that the gains to shareholders exceeded the costs (www.calpers.ca.gov).
It is important to use key stakeholders to influence the need for improvement and more transparency so as to keep them all satisfied and more socially responsible as a company. This decision could effectively lead to a positive share price reaction.
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