Charles' Book Club: How Important is Company Management?

Is there more than company performance and profit values that makes a company's stock a good or bad investment? Let's say you've done your research on Company A. You've checked through all its balance sheets and income statements and everything looks in good financial health. But there's something that you may have left out, and something that many other investors forget to take into account when investing in a company: how well is it managed?

In Value Investing Today, Charles Brandes goes into this issue of good corporate governance, discussing the relationship between shareholders and managers. In a company, shareholders represent ownership, looking to maximum their returns on their investment in the company. Management, on the other hand, represents control, handling the daily activities of the running of the company. Ideally, managers are tasked with helping shareholders reach their goals of maximizing their returns on their investment. However, there are cases where management may be more concerned with keeping their jobs or increasing their control, regardless of the financial impact on the company.

An example of bad corporate governance that made headlines in 2008 was the fall of insurance giant the American Insurance Group (AIG). After a series of poor internal decisions made by executive and board members as well as cases of extravagent salaries and bonuses, the company was in risk of bankruptcy, only to be saved by the largest ever government bailout to a private company, totaling to $182 billion. While this is an extreme case of poor management in recent times, it still illustrates the consequences of poor corporate governance.

Like the checks and balances in the U.S. government, it's important to establish similar checks in a company, separating the powers of the board of directors and the executive officers of a company. To avoid conflicts as a shareholders, there are five aspects of company management that should be looked into before investing:

1) The board of directors should have a majority of truly independent, nonexecutive directors.

2) The board should have a nomination committee, responsible for proposing director nominees.

3) The board should have a compensation committee, responsible for establishing fair and transparent compensation of executive directors.

4) The board should have an audit committee responsible for interacting with outside accountants and ensuring integrity of the company's financial information.

5) A company should have effective, transparent, and fair proceures for conducting shareholder meetings and for allowing shareholders to exercise their votes.

So as a suggestion to all investors looking into individuals companies, it's always important to also take corporate governance into account before making decision to buy.