How many times have you heard, "Don't put all your eggs in one basket"? While that is usually advice to diversify your investments, it can also apply to management of the companies you invest in. It requires an extraordinary amount of trust to invest in a company where all the management eggs are in one basket -- one person -- because of the risk that the right hand may knoweth all too well what the left hand is doing. And cover it up.
The most important top positions are chief executive officer (CEO), chairman of the board of directors, and chief financial officer. Without some strong reason otherwise, it's best if the first two are different people, and neither of the first two two should ever also be CFO.
Within reason, the more people review things at the top, the more likelihood that sunshine will reveal the true nature of the business' performance. Notice I said only "more likely," as it's clear that for some companies corporate culture ensures a clubby protect-each-other atmosphere. It's not unreasonable to invest with the rebuttable presumption that management operates for the benefit of shareholders only under duress.
The vision thing
However, it may not be the worst thing if the CEO and chairman are the same person in a riskier, development-stage company. An investor might want the visionary to have lots of control -- it's that person's moxie, after all, that probably attracted venture capital, launched the company ship, and navigated it across a sea of monsters.
Do you really want to run by committee a company that's trying to upend an established industry or create a new one? Probably not. Think Jeff Bezos at Amazon (Nasdaq: AMZN) or Steve Case with America Online before it became AOL Time Warner (NYSE: AOL).
What's in a name?
The titles do not always mean control. Bezos owned huge amounts of Amazon shares, and today still owns 29.3%, so whether you call him the receptionist or the CEO, he's controlling the company. Ditto the Ford family at Ford Motor (NYSE: F) or the Rigas clan formerly at Adelphia Communications, now trying out prison stripes. Warren Buffett owns 31.2% of Berkshire Hathaway (NYSE: BRK.A), and no one doubts who's running the show there.
If we invest in companies like these with a large-percentage owner who is very active in management, it's because we trust that owner. That was a big mistake with Adelphia, but so far it's been rewarded with Buffett and, depending when you bought, Amazon. With Buffett and Berkshire, I imagine that shareholders accept the concentration of control in Buffett because he has built a reputation for unassailable honesty. Buffett's annual letter to shareholders reveals the good, the bad, and the ugly in plain language. He builds trust year in, year out.
A large-percentage owner may not always pull the strings. It's hard to know. How much control does Swiss-based drug maker Roche Holdings exercise for its 59.6% ownership of Genentech? Or Eastman Chemical (NYSE: EMN) and Danisco for their 42.8% shares each of Genencor? Sometimes a large shareholder is known to exercise less control, say, as the Hershey Trust at Hershey Foods (NYSE: HSY).
The importance of appearances
Investors should begin with the assumption that concentration of power -- whether in percentage ownership or the chairman and CEO is the same person -- is a sign to nose around some more. Check the board of directors for independence.
I should have followed my instincts and avoided a debacle investing in a small Denver telecom equipment maker, Vari-L, which was formerly listed on the Nasdaq. The founder, who was at various times more than one of the CEO, chairman of the board, chief scientific officer, and president, had placed his sister on the board. She had no discernible qualifications for any corporate oversight position. Who thinks she would question her brother?
When I've seen relatives and friends of execs appear on small company boards elsewhere, they at least wear fig leaves of experience. I saw this and ignored it. Sadly, it all came to a bad end at the SEC.
A year ago, a larger but still developing company, Vertex Pharmaceuticals (Nasdaq: VRTX), appointed Chairman and CEO Joshua Boger's brother, Kenneth Boger, as senior V.P. and general counsel. Kenneth Boger has advised the company as outside counsel for years. Do I have any reason to doubt that he will provide excellent legal advice? No. [The following was edited 4/8/03, and the Kennedy reference was added.] But remember President John Kennedy's appointment of his brother Robert to be Attorney General? There's a reason we don't see this kind of thing anymore. Vertex pays a small appearance price, in my book, even if there's nothing wrong. I sold for other reasons, but this didn't help.
Now, here's a problem
But if you want to see great potential for mischief, look no farther than Minneapolis-based Techne (Nasdaq: TECH), a maker of biotechnology and hematology products, which vests the following roles all in one person:
Chairman of the board
Chief accounting officer
Chief grand poobah of the universe of everything bar none ad infinitum
(Just kidding about that last one.)
The talented Thomas Oland has been an officer since 1985. At first glance, there are no reasons to question his management, no obvious funny entries in the 10-K. During his 17 years at the company, he has delivered significant shareholder returns. In recent years, he is hardly to blame because Techne rode the wave of biotech speculation in late 1999 and early 2000 -- he can't do much about stock price in the short term. Where he can matter is with the business, and that has grown slowly but steadily for many years.
Despite the many hats Oland wears, the most recent proxy statement shows that he earned $225,000 in 2002, a mere 7.5% more than the vice president for research. He waived his cash bonus and didn't receive one in 2001 and 2000. Nor did he get any new options in grant in 2002, and the company has issued options net of cancellations at a low rate -- the highest a low 1.43% in 2001.
Oland has plenty of stock already -- he owns 4.2% of the outstanding shares and has options on 400,000 more, dating from 1996 at about an 85% discount to its close yesterday, so he knows where his future gains lie. And he saves the company money by occupying at least three positions that would cost Techne a minimum of $200,000 each, plus benefits and stock options, to fill.
My one curiosity? The employment agreement between Techne and him. Unlike those with other key officers, Oland's is oral. Hmmm.
There may be no problem here. It may be that the change in auditors last week was completely innocent -- an argument over fees or even a pro-investor decision to change chairs every few years. The problem is that, when so much power is in one place, the most innocent thing may be suspect. Thomas Oland may be the most honest, decent, trustworthy Boy Scout on the planet, and if you are a Techne shareholder, he'd better be.
But these are too many "mays" for December. The very risk that there is more than meets the eye at a company where the chairman of the board, the CEO, and the man who controls the money are one and the same should counsel investors to exercise great caution.
Updated portfolio returns appear below, showing that the Rule Breaker Port is ahead of both the S&P 500 and the Nasdaq for the week, month, and year. Have a most Foolish week!
Tom Jacobs (TMF Tom9) sings baritone in the merry band of Motley Fool investment analysts that bring the best investment ideas to you every month in The Motley Fool Select. Enjoy your 30-day free trial today! At press time, he owned no shares of companies mentioned in this column. To see his stock holdings, view his profile, and after clicking your heels three times, check out The Motley Fool's disclosure policy.
Rule Breaker Portfolio Returns as of 12/02/02 Market Close:
RB S&P S&P 500 Port 500 DA* Nasdaq Week 2.08% 0.18% -- 0.19% Month 14.42% 5.51% -- 11.66%
Year -15.41% -18.60% -- -23.87%
using IRR** since 8/4/94*** 22.55% 8.92% 10.77% 9.07%
10/20/98*** 4.45% -5.79% -4.15% -6.87%
*Dividends added. Or, danger ahead. Whatever.
**Compound Annual Growth Rate using Internal Rate of Return. This performance measure is more meaningful than total return because we began adding cash occasionally in July 2001. In a total return calculation, or ((Current Value - All Cash Deposited)/All Cash Deposited), cash added would show up as returns. And that wouldn't be cricket!
***What's this? The Rule Breaker Portfolios' precursor, the Fool Portfolio, was born Aug. 4, 1994. In a 10/20/98 column, David Gardner announced the name change of the Fool Portfolio to the Rule Breaker Portfolio. Here we provide returns as if the RB Port started on either date. Remember, don't mimic any online portfolio. Most individual investors should restrict any positions as risky as these to under 20% of their portfolio -- and could have a happy long investing life with zero.