Would you sail across the Atlantic with a captain and crew you knew little about or, even worse, didn’t trust? Of course not. This same concept applies to management of a company in which you buy stock. Understanding who is running the company and what their underlying motivations are is extremely crucial.
Management Background
It is important to evaluate the track record of the management team as if you were interviewing someone for a job. Do they have a history of success or failure when it comes to executive management? Did they spend time working for any elite “thinking” organizations like McKinsey & Company (this doesn’t mean everything, but at least you know they have been vetted to an extent in a high performance environment). But what matters most is not necessarily the resume. Often, what matters most is if they are trustworthy and have a reputation for following through on commitments.
Can You Trust the Trustee?
The management of a company should be committed to the success of stockholders, and should always act in their best interest. This means making an effort to maintain a relationship of trust with shareholders. For example, when the team files financial statements with the Securities and Exchange Commission (SEC) they should clearly communicate their goals and objectives and act in the spirit of full disclosure. The 10-K (the annual company report) has a section that outlines management’s analysis and outlook for the business. I like to see conservative language and a discussion of risks to the business.
Further, is the structure of the business shareholder friendly? A dual-class stock structure which gives insiders and management the ability to take full control of the company is typically unfavorable. The means shareholders cannot influence a change in management if executives aren’t acting in the best interest of the firm.
Are Your Goals My Goals?
In addition, it is important that incentives for the management team are aligned with value creation for shareholders. This means the management team needs to have a stake in the success or failure of the company as well. For example, increased compensation and stock awards or options should be contingent on management meeting revenue or profit targets.