Discover more from Course Notes: Continuous Business Learning
Helps with integrating corporate governance into the investment process.
Stands for: Greed, Opportunity costs, Valuation, Executives, Referendum, Narrative.
The glue of all these components is compensation, of course.
Greed is not bad in itself, what makes a difference is the object of this greed.
Financial investors’ greed when they try to offload a big chunk of their holdings, thus damaging the stock price and generally – the company’s prospects – is bad for everyone but the said investors.
The greed for power and reputation may turn an insider into a narcissist pleasing not just internal stakeholders, but also actively creating external CxO / Directorship opportunities.
Empire building / hoarding cash for the purpose of having more M&A opportunities (meaning more power) or having misaligned compensation incentives is also a result of greed.
So the key task is figuring out what the insiders are greedy about as this will explain what drives their decisions.
Aggressive equity grants and changes in cash/equity comp sends strong signals on insider sentiment and performance expectations.
Governance is about managing opportunity costs and trade-offs. (To understand opportunity costs better you can read a complex but incredible useful book “Economics in Two Lessons” by John Quiggin).
Greed is linked to opportunity costs in a way that narrowing the opportunity costs for the management (especially around comp) means widening them for investors.
Not rocking the boat (i.e. not taking enough risks) can be considered a risk-averse behaviour of the management to the detriment of the long-term company interests.
Asymmetrical risk profile (good capital decision == managers get bonuses; bad decision == shareholders foot the bill) is another example.
Lowering targets for the sake of bonuses and indexing the payout based on overachieving targets is yet another way of almost risk-free value transfer from shareholders to execs.
The “quality” of capital allocation goes hand in hand with managing opportunity costs by the Board.
Increasing stock price helps (and encourages) aggressive M&A (since it’s cheaper for the buyer and still valuable to the seller) or increased CAPEX.
Boards encourage this risk-taking behaviour and swap options for performance shares (i.e. higher total payout to the management).
Valuation is one of the key drivers of the changes in exec comp, and it reflects the perception of the Board regarding the planned outcomes.
A company’s government structure resembles the comm and org power structure that produced it. In other words, the positional and information powers play a big role in defining who gets what.
The exec comp structure is the best indicator of the Board dynamics; corp governance structure and practices tell a lot about the execs and their values.
The dark arts are quite visible when the performance goalposts are moved by the Board in the management’s favour and towards their preferred strategy.
Directors (believe it or not) are elected now and then. And activist investors can really make changes.
The question is: do execs and the incumbent Directors entrench themselves (looking for the sources of power to keep it) or do they (maybe) listen?
On the other hand, if things go well, are there obvious red flags being ignored for the sake of keeping the growth going and not rocking the boat?
The Board communicates the company’s narrative (i.e. the “North Star”) to the world. It’s a brilliant PR/IR exercise, but is the company really going for it? Are the execs being judged based on the alignment with the path to reach this North Star?
A narrative that stays the same for a long time is outdated and thus should be discounted; a change (hopefully towards something more realistic) is something to look carefully into.