And so the story goes, with the smartest people in the room managing our money, good things will happen. Unfortunately, the finance industry has built giant empires and many fortunes around self-interest of another kind – its own. The finance industry may have smart people working in it, but it also has many conflicts of interest between what is in the interests of the industry and its many players and the interests of the general public. And we have known for a long time that markets are not always good ways of protecting against these conflicts of interest. On the contrary, sometimes it just allows some self-interested players to make huge gains at others expense.
And as the global financial crisis has unfolded we now have insights into just how big the gains were for some, and how costly they were to us. There are other ways that we make institutions perform in our best interests. One mechanism is to have a voice on the decision-making body. From parliaments controlling our taxes to companies controlling our investments, representation is a well established way of tying the decision-makers to our best interests. Representation doesn’t guarantee performance, and we know that bringing together people with diverse personalities and backgrounds is not easy.
But without direct participation, representation is one of the best mechanisms humankind has established to ensure our interests are protected. In particular it helps to deal with one of the finance industry’s key problems – too many conflicts of interest. To take one example, many superannuation/pension funds are run by trustees who are both meant to represent fund members and are effectively employees of the financial institution running the fund. Research by legal scholars and financial economists have identified this sort of conflict as quite damaging to fund performance.
Even industry insiders like Vanguard’s John Bogle has been extremely critical of such conflicted arrangements. In the Australian superannuation industry, representation is a feature of one type of fund, the not-for-profit funds. These include public sector, industry and company funds and they typically have equal representation of workers and employers.
In research* we have just completed on the link between governance and performance in the superannuation fund industry we found that there was a link between representation and better fund performance. Using almost 5 years of fund data for default funds, where most members have their savings, and employing a well-established fund performance methodology, we found that funds with representative trustees outperformed those with appointed trustees by up to 2.4 percent per annum.
