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Z01_JOHN2020_09_SE_EM10.QXD CASE STUDY Hermes Fund Management, Total and Premier Oil: the responsibility and accountability of business David Pitt-Watson and Gerry Johnson This case raises two key questions: Is it the responsibility of institutional shareholders to intervene in the strategies being followed by companies in which they invest? If so, in which circumstances and how? ● ● ● under house arrest. There was no free press. Widespread human rights abuses had been reported, including some associated with the building of oil and gas pipelines. Internationally, politicians had been vocal in demanding that companies think very carefully about whether they wished to maintain operations in Burma. However, most had fallen short of passing laws to enforce this. ‘But there is a difference here’ said Natacha: This is Total making an improvement to their operations. Total has made a competitive advantage of operating in troubled regions. And we can’t possibly persuade them to get out, even if it is the right thing to do: we only have a small shareholding. And in any case, there is little evidence that companies withdrawing their investment brings about positive change. In fact the assets are sold to those with fewer scruples. Yet some eight years previously Hermes had worked with Premier Oil, the other leading Western investor in Burma/ Myanmar. That had resulted in Premier’s disinvestment of its Burmese operations to Petronas, the Malaysian oil com- pany, and a number of other changes to its governance, strategy and financial performance, all of which had proved positive. ‘Surely’, thought David, ‘Total was similar. Surely, for consistency, Hermes should not only refuse to go on a controversial trip to Burma, they should also seek to persuade Total that they should disinvest.’ But Natacha also had made some good points; Total was larger, Hermes’ shareholding smaller, it was a French company with good financial performance and underlying government support. It would be very costly and time- consuming for shareholders to put proper pressure on the company. Moreover, many believed, like Milton Freidman, that the prime duty of a company was to make profits. If so, that was what Total was doing. Its business model was Déjà vu? It seemed like a simple decision, but the issues it raised were surprisingly controversial. It was 2008, and the staff of Hermes Equity Ownership Service (EOS) were gathered for the weekly meeting. Natacha Dimitrijevic raised an issue which had come to her desk. Total, the giant French oil company, was inviting selected shareholders to look at some of the initiatives it was taking in promoting corporate responsibility. How should Hermes respond? Historically, Total had never had a great reputation for Corporate Social Responsibility (CSR). Its environmental record, for example, had been tarnished by, among other things, its involvement in a large oil spill a decade ago, which had devastated the French coast and was only now being decided by the courts. Whilst its European competitors, BP and Shell, laid claim to addressing CRS issues, Total had a public reputation as a laggard. It therefore came as a surprise, to many a pleasant surprise, to discover that it was now taking CSR issues seriously. But the invitation to shareholders which Hermes had received was not to visit any operation. It was to visit Total’s operations in Burma/Myanmar. ‘I really don’t see how we can do that’, said David Pitt- Watson, founder of Hermes EOS, and in 2009 its senior advisor. First, it will be hugely controversial for anyone to visit that country. Second we have history in this one. We were the ones who persuaded Premier Oil to disinvest from Burma; we can’t condone others operating there. In fact we should consider a serious engagement to persuade Total to get out of the country. The regime in Burma had, for many years, been a military dictatorship. Its elected leader, Aung San Suu Kyi, was This case was prepared by David Pitt-Watson and Gerry Johnson. It is intended as a basis for class discussion and not as an illustra- tion of good or bad practice. © David Pitt-Watson and Gerry Johnson 2010. Not to be reproduced or quoted without permission. Z01_JOHN2020_09_SE_EM10.QXD 10/13/10 9:05 Page 605 606 HERMES FUND MANAGEMENT, TOTAL AND PREMIER OIL based on its skills to access and exploit oil and gas reserves in technically or politically difficult areas, mostly in non- OECD countries. For Total to leave Burma/Myanmar could be strategically problematic and potentially undermine the company’s relations with other host governments. Set against these reasons for staying in Burma was the financial risk to Total if there was a change of regime, or sanctions imposed by the UN or the EU. David and others had worked hard at Hermes, develop- ing a strategy of fund management that made it distinctive from its peers. Hermes aimed to be a responsible owner of the companies whose shares it held on behalf of its clients. Whatever else Hermes said or did, it needed to have a view about whether Total was acting properly. And if it did intervene, it needed to be careful this was not some ill-thought-through initiative which was not in Hermes’ clients’ interests. All this caused David to reflect on the Hermes approach which he had helped develop over 10 years. And, more specifically, on the Hermes engagement with Premier, resulting in its withdrawal from Burma/Myanmar in 2003 and the positive response of the share price that had seemed not only to be a step forward for the company, but also a vindication of Hermes’ approach to Fund Management. Was Total really so different? Or might it have been wrong to pursue the case with Premier Oil in the first place? And in any case, what could and should a shareholder do? Hermes and its investment philosophy Hermes is the principal manager for the BT Pension Scheme and manages investment on behalf of other pension plans. It is one of Britain’s most influential fund managers with around £40 billion1 (x44bn or $60bn) under manage- ment, just under 1 per cent in the shares of most British companies, and about 0.3 per cent of those in continental European companies. It is one of the few large pension fund managers not owned by a bank or other large financial institution, and hence believes it offers a service which is independent of the conflicts of interest experienced in most large financial institutions. For many years it had taken a lead in promoting better management and governance and in intervening where there were continuing problems with company performance. The central foundation of Hermes’ approach was the observation that most investment managers do not try to influence the performance of the companies in which they invest; particularly on longer term issues. Like any company, their aim is to maximise the returns to its own shareholders. They did this in the main by buying shares they believed to 1 The exchange rate used is £1 = Euro 1.10 and £1 = $1.50. be cheap, and selling them when they seemed expensive – a process described by Warren Buffet, the leading American investment manager, as ‘gin rummy behaviour (discard your least promising business at each turn)’. Hermes philosophy was based on the belief that com- panies with engaged and active owners were likely to be worth more than those allowed to behave without any such constraint. This philosophy applied to all Hermes’ equity holdings through its ‘Equity Ownership Service’. Hermes was therefore passionate about governance; ensuring that the board of a company has the right mix of entre- preneurship, expertise and independence to maximise the company’s value. But such a philosophy had its downside. If shareholders seek to micro-manage companies, they can create chaos, especially given that most public companies have thousands of shareholders. Hermes believed, however, that, if share- holders do not take seriously their role as owners, as ‘good stewards’ on behalf of their clients, company boards have no one to whom they can be accountable. Like Adam Smith the company believed that this would create ‘negligence and profusion’ as company management would work for themselves rather than their shareholders. For Hermes, successful stewardship involved using its vote in approving the board of directors, but also interven- ing in companies which were failing to resolve crucial issues, such as board structure, strategic direction, capital structure and corporate governance. David commented: Hermes’ philosophy is different from most funds. It seeks to create value for our clients in the companies in which it invests, not just trying to pick winners. I wonder, was it in our clients’ interest for Premier Oil to have been in Burma/Myanmar, and for Total to be there today? And being pragmatic, should we be devoting resources to this? Premier Oil He reflected on Hermes’ engagement with Premier: Premier had problems beyond those of its trading in Burma/Myanmar. On the governance side, the funda- mental issue was that the company was dominated by two major shareholders, Amerada Hess, a US company, and Petronas, the Malaysian National Oil Company, each of which held 25 per cent of the shares. Not content with the control and influence they wielded as such major shareholders, each of them also had two non-executive directors (NEDs) on the board. Hermes also deemed two other NEDs to be non-independent. We believed these board problems were reflected in a failure by the company to address some of the Z01_JOHN2020_09_SE_EM10.QXD 10/13/10 9:05 Page 606 HERMES FUND MANAGEMENT, TOTAL AND PREMIER OIL 607 problems it faced. It was in a strategic hole. It was not large enough to compete in production and downstream work with the emerging super-major oil companies, but not as lightweight and fleet-of-foot as it needed to be to fully exploit the exploration opportunities opened up by the super-major’s focus on larger scale fields. It had also allowed itself to become exposed to major ethical and reputational risks as a result of being the lead investor in the Yetagun gas field in Burma/Myanmar. Yes, it had done positive work in Burma/Myanmar, including building schools, funding teachers, AIDS education and environmental remediation. But this country was ruled by a military dictatorship which had refused to accept the results of democratic elections in 1990, where summary arrest, forced labour and torture were widely reported, and which had therefore become a pariah state. We were also concerned that the board had not publicly stated how it was effectively managing the risks associated with its presence in Burma/Myanmar, or that the board, as it was constituted, could give shareholders the reassurance that they needed in that regard. Premier’s share price had dramatically underper- formed the market for several years. That came as no