Careful Investors look for Signs of Quality Management

One of the main factors determining the success of a corporation is the competence of management.

Buy into companies with "good management."


But in practice, how do you know?

• Ideally you begin by meeting management.  However, the door is open to very few and the ability to assess it is just as limited.
• The practical approach is to begin by looking at the record.

Practical Approach:  Looking at the Record

If a company's earnings are increasing, this is one piece of evidence pointing to good management.

• However, the results must be measured against others in the same industry.  
• Otherwise, a management which swims with a favourable tide may get more credit than it deserves.  

Often a superior management fighting bad conditions is unjustly criticized.


Type of Management Counts

Is the company in question headed by an old-fashioned entrepreneur who has made management a one-man show?

Or does it have good management in echelon depth which can survive the retirement or death of its chief executive?


Officers' shareholdings

One aspect of management worth noting is the extent to which the officers own their own shares.

Broadly speaking, it is advantageous for the officers to have a stake in ownership.

It makes a difference whether they own the stock

• because they want it or 
• because they are stuck with it.

You should consider whether they

• acquired it through inheritance, 
• bought it on option, or 
• bought it in the open market.  

Likewise, where possible, consider the purchase date and price paid.



Close Watch Pays Off

One of the many ways of making money in securities, is through a close watch on management.

Watch and understand the changes where companies have been in difficulty, their stocks depressed and general dissatisfaction expressed and where a new management comes in and invariably begins by sweeping out the accounting cobwebs.

• Everything is marked down or written off so that the new management is not held accountable for the mistakes of the old.  
• Very often dividends which were imprudently paid are cut or passed.  
• Thus an investor at this juncture often gets in at the bottom or the beginning of a new cycle.
• A recent example:  TESCO London.

Conclusion:

Attempting to evaluate management, even though you cannot get all the answers, is worth all the effort it entails.



Related post:

Management Compensation
https://myinvestingnotes.blogspot.com/2010/04/buffett-1994-in-setting-compensation-we.html

Performance management systems.

These systems align decisions with short- and long-term objectives and the overall strategy.

Such systems typically include:

• long-term strategic plans,
• short-term budgets,
• capital budgeting systems,
• performance reporting and reviews, and 
• compensation frameworks.

The rigor and honesty of implementing the system is at least as important as the system itself.

Implementing the system includes

• choosing the metrics, 
• composing the scorecard, and 
• setting the meeting calendars.

1.  Choosing the right metrics

Choosing the right metrics means identifying the value drivers.

Typically the ultimate drivers are

• long-term growth,
• ROIC, and
• the cost of capital.

Short- , medium-, and long-term value drivers determine growth, ROIC and the cost of capital.


Short-term value drivers

Short-term value drivers are usually the easiest to quantify, and examples include

• sales productivity,
• operating cost productivity, and 
• capital productivity.

Medium-term value drivers

Medium-term value drivers consist of

• measures of commercial health, 
• cost structure health, and 
• asset health.

Long-term value drivers

Long-term value drivers address strategic issues such as

• ways to exploit new growth areas and 
• the existence of potential market threats.

Understanding the value drivers allows the managers to have a common language for their goals and to make better choices of trade-offs between critical and less critical drivers.


2.  Composing the Scorecard


Balanced scorecard approach

This was introduced by Robert S. Kaplan and David P. Norton in "The Balanced Scorecard:  Measures That Drive Performance" (Harvard Business Review, February 1992).

This approach can reflect many aspects of the firm and its goals.

The choice of critical drivers should be tailored to the firm's businesses.



A tree based on profit-and-loss structure approach

This is often the most natural and easiest to complete.

The targets need to be challenging and realistic, however, and should not consist of only a single point.

One recommendation is the use of base and stretch targets, where achieving the latter reaps a reward for the manager and not a penalty.



3.  Organizational Health

In addition to determining the drivers and targets, managers should assess organizational health, which is determined by

• the people, 
• skills and 
• culture of the company.

Managers should help set the targets to better understand these issues.

Fact-based reviews with appropriate rewards should depend on:

• stock performance where macroeconomic and industry trends have been removed,
• long-term assessments that might mean deferring rewards, and 
• measures of performance against both quantitative and qualitative drivers.

The firm should harness the power of nonfinancial incentives, such as creating a culture that attracts and motivates quality employees.

Highest Paid Directors

2012


2011

Warren Buffett - Absurd CEO Salaries and How Should a CEO Be Compensated?

Sound Management: HOW CAN THE AVERAGE INVESTOR JUDGE MANAGEMENT?

WARREN BUFFETT’S CONTINUING THEME

If there is one theme that continually runs through the public statements of Warren Buffett it is the principle that investor should only consider for investment companies with managers of competence and integrity.

HOW CAN THE AVERAGE INVESTOR JUDGE MANAGEMENT?

The difficulty of course for the average investor is how to determine if a company is soundly managed. Warren Buffett is a rich man and a big investor and, while it is not known if he ever does this, he would be able to question internal company management a lot easier than John Citizen.

The answer for the average investor is to extensively research a company before investing and to ask the kind of questions that it seems Warren Buffett asks before investing in a company.

Buffett (1994): "In setting compensation, we like to hold out the promise of large carrots, but make sure their delivery is tied directly to results in the area that a manager controls.

Warren Buffett wrote on how corporate managers destroy shareholder value by resorting to unwanted acquisitions through his 1994 letter to shareholders. Let us proceed further in the same letter and see what other investment wisdom the master has to offer.

The current mortgage crisis in the US has put the global economy on the brink of a recession and has made big dents in the balance sheets of some of world's top financial institutions. Thus, with damages of such a magnitude, it is only natural to assume that the heads of these institutions during whose tenure the crisis took place should face financial penalties of some kind. However, if the pay packets of some of these executives are any indication, people harboring such notions are doing nothing but wallowing in outright fantasy. As per reports, CEOs of some of these institutions who have posted billions of dollars of losses due to the sub prime crisis will continue to rake in millions of dollars. All that shareholders get by way of solace is their ouster by the board or voluntary resignation. So much for alignment of shareholders' interest with that of the CEO or the management!

This is not a standalone case and there have been many such instances in the past where despite bringing companies down to their knees, CEOs and top management have gone on to earn fat salaries. Certainly, boots that all of us would love to get into! After all who would not want to lead a company where while salaries are tied to profits on the upside, there is no financial punishment to speak of when losses happen by the billions.

Yet, practices like these are commonplace in the corporate world and year after year, shareholders of troubled companies have to bear the egregious costs of the animal like aggressive instincts of its management. Thus, in order to avoid traps like these, it becomes important that when we as investors invest, we should have a close look at the compensations that the management gets in times both good as well as bad and see whether the company has a proper compensation system in place. A lot can be learnt if we have a look at how the master plans compensation for executives in the companies Berkshire own and his views on the issue. This is what he has to say on fair compensation practices.

"In setting compensation, we like to hold out the promise of large carrots, but make sure their delivery is tied directly to results in the area that a manager controls. When capital invested in an operation is significant, we also both charge managers a high rate for incremental capital they employ and credit them at an equally high rate for capital they release.

It has become fashionable at public companies to describe almost every compensation plan as aligning the interests of management with those of shareholders. In our book, alignment means being a partner in both directions, not just on the upside. Many "alignment" plans flunk this basic test, being artful forms of "heads I win, tails you lose."

In all instances, we pursue rationality. Arrangements that pay off in capricious ways, unrelated to a manager's personal accomplishments, may well be welcomed by certain managers. Who, after all, refuses a free lottery ticket? But such arrangements are wasteful to the company and cause the manager to lose focus on what should be his real areas of concern. Additionally, irrational behavior at the parent may well encourage imitative behavior at subsidiaries."

http://www.equitymaster.com/detail.asp?date=2/21/2008&story=3