Coffee Shop the Case Regarding Hermes Fund

Coffee Shop

The case regarding Hermes fund management supports a much larger and contentious theme regarding investment management. Are managers responsible for the social initiatives of their shareholders? More important is it a fund manager's duty to uphold the social and political aspirations of their shareholders. As the case illustrates, the duty to both shareholders and society is indeed a fine line.

In regards to the case Hermes is correct in its activist stance towards investing so long as it benefits the shareholders in which they represent. As the case illustrates, Hermes has many risks that it must properly navigate in order to provide capital preservation for its shareholders. One such is risk is reputational in nature. As Total continues to conduct business in controversial countries, Hermes is subject to various risks to its reputation, which could ultimately cause redemptions in its funds.

However in regards to many of the more subjective risks, Hermes should not interrupt the business operations of the firms in which they invest. The primary purpose of business is to generate profits for its owners. Milton Friedman, himself taught this concept extensively throughout his prestigious career. As such many of the more socially or morally correct governance practices should not be pursued by Hermes fund managers. For one, the fund undoubtedly has numerous shareholders. As one of the better known firms in the industry, the firm is responsible for management activities for individual investors, endowments, and pension funds. As such, the firm does not have the right to promote social issues that it deems necessary. By doing so, the firm alienates one section of investors in favor of another. This is not the firm's duty. Instead, if the firm is doing its job in regards to capital appreciation, individual investors will have the opportunity to purse social initiatives that they themselves deem worthy. In regards to the Total's operations in Burma, the firm should focus solely on the risks involved in doing business in the county. The firm should not attempt to take or promote social action within the country itself.

Based on this concept, I believe Total should continue doing business Burma so long as it is in the best interests of the Hermes shareholders. In order to properly ascertain the shareholder oriented nature of the Total's operations, more governance and oversight should be created. Management of Total should provide concrete initiatives it plans on undertaking in the Burma area in order to assuage investor concerns regarding operations. Hermes should also take on a more activist role in regards to the underlying business operations of Total. The approach should be similar to that used with Premier Oil. In many instances, both management and shareholders want to generate shareholder returns far superior to that of the overall market. Premier Oil is a perfect of example of unlocking shareholder value for the benefit of all. Prior to discussions with Premier Oil the stock lagged behind both the general market and its peers

Finally, the case ends with a very interesting question regarding what management should discuss at the conference in regards to corporate responsibility and the shareholders right to promote it. In regards to this question, the management of Hermes should discuss the principle-agent problem as it relates to shareholders and management.

Academics describe the principal-agent problem as one that constantly devalues shareholder wealth (Eisenhardt, 1989) . This literature, describing the devaluation of shareholders is consistent with the prevailing principal-agent sentiments. This pertains primarily to options and risk taking behavior on the part of management.

Another answer to this question pertains mainly to management as owners vs. management as representatives. This statement may seem one in the same but prior to 1990, management's duties and responsibilities where polar opposite to those of today. In the 1980's management was seen primarily as a "representative" of the entire business entity. As a result, stockholder and investor interests where junior to the needs of the overall business. Managers did not use assets in a manner is which stakeholders benefited. In fact, most management was inclined to underuse capacity. Companies with competitive advantages such as economies of scale or distribution networks simply did not use them to their fullest extent. This benefited the manager who had compensations packages that were based very loosely on metrics that can be easily manipulated. This metrics included revenue, earning per share, and sales growth (Kaplan, 2012). All management had to do was to simply alter assumptions within the annual report to "create" earnings or manipulate earnings as their compensation was not in the form of stock. For example, the literature indicates one commonly used method in which earnings can be "created" or "manufactured" is by manipulating the pension fund assumptions in the annual report. By "expecting" a higher growth rate within the pension fund, a company can contribute fewer earnings to fund the pension. These pension savings are then transferred to the bottom line as a profit increase, when in reality; the increase was a result of accounting gimmicks (Shaw, 2012). Such was the case in the 1980's as many companies used these gimmicks to manipulate financial information. To be fair, the 1980's and prior decades where marked with economic uncertainties that created a sense of caution among businesses. This cautious attitude can reasonably attribute to the notion of unutilized capacity. However, this underused capacity was still a detriment to shareholders as costs per unit and overhead per unit increases due to this unused capacity. What would eventually ensure was a wave of hostile takeovers and proxy fights in an effort to better align corporate goals with those of its owners. Many investors who found companies with assets that where not utilized to their fullest potential would simply obtain a majority stake in the business and either sale or use those assets to generate profits or cash. Companies began to take notice and began to better align corporate objectives with owner objectives through the issuance of stock options