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Lucy Battersby
April 6, 2009

THE serendipity of the economic disaster unfolding around the world is that it is an opportunity for capitalism to purge itself of practices that look great on the next annual report, but are disastrous in the long-term.

Capitalism already has a mechanism that should have prevented the financial crisis: long-term investors.

But the concerns of individual or long-term investors were often ignored in the euphoria of economic growth that preceded this crisis, to the dismay of anyone planning to retire in the next five years.

This is where people like Colin Melvin come into the picture.

Mr Melvin is a quiet Brit who represents £50 billion ($A100 billion) belonging to pension funds around the world through his role as chief executive of Hermes Equity Ownership Services, which is owned by the British Telecom Pension Scheme and partly owns Australia’s Regnan Governance and Engagement.

Unlike short-term investors, superannuation funds keep their money in companies for 10 to 15 years and know that is sufficient time for poor management decisions to destroy a productive company.

Mr Melvin and his London-based staff examine company management, structure and practices and look for unsustainable or unethical practices. They then engage with the company on behalf of the funds, fixing any potential problems.

“Companies that do the right thing make more money in the long run,” Mr Melvin said in Melbourne a few weeks ago. “The task is to work with the company and encourage them to accept change.”

If capitalism is to survive without excessive government regulation, long-term institutional investors need to harness their power through representatives like Hermes and Regnan.

The point of this column is not to give Hermes and Regnan a free advertisement, but to demonstrate they can succeeded where regulators, unions, the media, pressure groups and individual shareholders cannot. Last year they confronted 450 companies around the world on issues ranging from corporate governance to child labour and corruption.

There are 30 million superannuation accounts in Australia with more than $200 billion invested in domestic and international shares.

Regnan represents $39 billion worth of superannuation investments in S&P/ASX 200 companies, but as with individual retail shareholders, it is far too onerous for super funds to keep an eye on all their foreign investments.

VicSuper is the only Australia company that uses Hermes to monitor foreign investments.

Even though these funds may own less than 2 per cent of company shares, they carry enough gravitas for company directors to agree to a meeting. “The contrast between us and an NGO or pressure group, who just look at the issue, (is) we support (the change) with a financial case,” Mr Melvin said.

Most boards know when there is a bad apple among directors, but it is difficult for one board member to oust another, Mr Melvin explained.

“Companies are often relieved to find someone in their shareholder base who is taking an interest.”

The financial crisis has increased awareness of the damage a bad corporate culture can do, and Hermes’ clients doubled last year to 11 funds.

Recently they started acting for a Canadian pension fund with investments in large American banks. “There were problems with risk management and pay structures, and we’d been raising these problems for several years. But the rest of the financial services industry was pushing banks in the opposite direction,” Mr Melvin said.

The question of whether shareholders, as the owners, or directors, as custodians, are responsible for a company’s behaviour often causes tension between the two parties.

So consider an argument put forward by two representatives from the British-based Relationships Foundation to a group of business and company leaders a few weeks ago.

Michael Schluter and Jonathan Rushworth have devised a “relational business charter”, which encourages company directors to consider the relationships in and around a company in making all decisions — such as keeping executive pay at a ratio to the lowest wage and treating suppliers fairly.

Many shareholders neglect their duty as company owners, Dr Schluter and Mr Rushworth argue, and should not profit from shares if they cannot participate in meetings and make time to analyse board decisions.

“What is the moral basis of expecting a return on capital without doing anything for it?” Dr Schluter asked.

Even bankers agree that sensible corporate governance and active shareholders are what keep companies profitable.

Stephen Roach, chairman of Morgan Stanley Asia, wrote in an opinion piece this year: “There has been a major systemic failure of the model that has held the world together since the 1930s.

“Governance, or the lack thereof … proved to be the weak link in the chain. Fix that, and capitalism will be just fine.”

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