Why You Should Care About Corporate Governance

One of our mantras at The Motley Fool is "do your due diligence!" This includes examining -- among many other metrics -- a company's revenues, earnings, cash position, return on equity, and … corporate governance.

Corporate governance? Yep. On a recent visit to Motley Fool headquarters, Nell Minow, editor and co-founder of research firm The Corporate Library, said the first thing investors should examine when assessing a company is executive compensation. "For most people, executive compensation is a once-a-year story -- who gets paid how much every spring when we see the proxy statements," Minow says. "To me, it should only be a starting point."

Minow says executive compensation is as important to understanding a company as free cash flow or any of the other fundamental indicators investors should examine. "In fact, it's less susceptible to manipulation," she says. "So in some ways it's a better indicator. It's a 365-day-a-year story."

When examining executive compensation, Minow says you should ask, “Is there an upside and a downside” to the pay plan? She says she finds that when there is no downside, people don't try very hard. And lazy management can translate to poor company performance -- which translates to poor stock performance.

Things investors should examine
Besides examining proxy statements for executive compensation, Minow says investors should look at who is on the board, how many boards they're on, what kinds of jobs they're doing on those various boards -- and whether they should be allowed to continue.

That information will tell you a lot about the CEO. "There's a strong 'emperor’s new clothes' syndrome in the executive suite," Minow says. "It is a very rare CEO who wants to surround himself with people who criticize him. When they surround themselves with people who don't know anything about business, or who are basically in their pocket, that's a bad sign."

When asked which CEOs she favors regardless of the grade they've been assigned by The Corporate Library, Minow cited Berkshire Hathaway's (NYSE: BRK-A  ) Warren Buffett, Costco's (Nasdaq: COST  ) Jim Sinegal, and JPMorgan's (NYSE: JPM  ) Jamie Dimon. On the other side, Minow cites Aubrey McClendon, the CEO of Chesapeake Energy (NYSE: CHK  ) .

Why McClendon? First, Minow says, because McClendon owned a lot of company stock and borrowed against it. When he got hit with a margin call because the stock was not doing well and had to sell it, Chesapeake's board gave him a lot of stock to make up for what he had lost.

The board also got the company to buy McClendon's antique map collection from him for $12 million. According to Minow, the person who advised McClendon to buy the maps was also charged with determining their value. "The board of directors is sending the wrong signal by taking the CEO out of any pain or concern about the bad performance of the company," Minow says.

More bad signs
If the CEO wants to keep control of the board, that's usually a signal that he/she won't pay attention to the other shareholders, Minow claims. She points to Martha Stewart Omnimedia (NYSE: MSO  ) and Adelphia (where the CEO kept voting control), as well as Hyatt's (NYSE: H  ) recent IPO, as examples. "If they want the access to capital of a public company, but the control of a private company, that's a short sell in my opinion, because they're not accepting the accountability of the public company system," she said.

The one exception, Minow says, is newspapers. She says there has never been a world-class newspaper that did not have dual-class capitalization. Minow notes that it's the only way to keep the news content separate from the pressures of advertising and politics. "Anytime a newspaper company has gone from dual-class to single-class, it's gone downhill," she said. "Look at the L.A.Times."

How the funds vote
Minow's company, The Corporate Library, publishes a report on how mutual funds vote on executive compensation. Minow says the voting by mutual funds in aggregate has actually gotten worse over time regarding executive compensation. "They have voted more in favor of bad pay plans," she said. "I continue to hope that sunlight is the best disinfectant and that people will choose the mutual fund that votes most energetically on their behalf."

Minow went on to say that the Labor Department, which has jurisdiction over pension funds (the largest collection of capital in the world), and the SEC, which has jurisdiction over mutual funds, have never suggested that voting is an important thing. "I think if they gave [mutual funds] a little nudge, that we'd see more rational votes," said Minow. "Shareholders are economically rational, and if there is a meaningful vote to be cast, they will understand that."

For more from Nell Minow:

Fool contributor Jennifer Schonberger does not own shares of any of the companies mentioned in this article. Chesapeake Energy, Berkshire, and Costco are Inside Value recommendations. Costco and Berkshire are also Stock Advisor picks. The Fool owns shares of Chesapeake Energy, Berkshire, and Costco. The Motley Fool has a disclosure policy.


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