It drives my wife nuts, but I love quasi-historical action movies like Troy. They're fun to watch, are historical in context (note: I didn't say accurate), and generally spend an arm and a leg on the effects budget and battle sequences. The kings, generals, and heroes in these movies are always fighting for a greater good, but inevitably, their cause becomes murky, or is appropriated by an individual's selfish interests. That's not so different from life -- or CEOs, come to think of it.
Like kings, some CEOs are power-hungry or greedy, while others are aloof. Kings had courts and CEOs have boards, but in most cases, the person in charge day in and day out is the one who's really in control.
All of these powerful folks have a number of people who depend on them, though not all of them realize it. As an investor, you'd better believe that the people in charge at the companies in which you invest have a direct impact on your potential returns.
What drives the boss?
Of all the questions an investor can ask themselves about a company, this one should be right at the top of the list: What motivates the folks in charge? If it's not a higher share price achieved over a long period of time, investing in the company may not be for you.
Many times, CEOs are motivated by being in control of a company and having the power to execute a strategy that motivates folks. In and of itself, that's harmless enough. At other times, it's the ability to use your corporate privilege to score a few uncommon perks for yourslef. Tyco (NYSE:TYC) is the most famous example of this behavior. The business itself was not and is not bad, but its CEO's choice to skim funds off the top for his own benefit was kind of a red flag for investors, to say the least.
I've been struggling with this issue at a company I own, Kenneth Cole Productions (NYSE:KCP). By all accounts, the company earns good returns, is growing, and pays a strong dividend, which I love. But I'm troubled by the options granted to founder and CEO Kenneth Cole. Given that he owns the majority of the shares outstanding, controls the shares with the supervotes, and earns a healthy salary, he's well-compensated. The options shouldn't be necessary to motivate Mr. Cole, but he's getting them anyway. As the options program is reasonable overall, this obviously didn't stop me from investing in the company, but it's something I keep an eye on.
The Web is your friend
I'd encourage every investor to run a Web search for any information about a company's CEO, board of directors, and management that you might not find in a company's SEC filings. You'll want to try and validate any scuttlebutt you find, but in some cases, you may just stumble upon documents that a company has filed with entities other than the SEC.
I've had my doubts about the health of the franchise system at Rocky Mountain Chocolate Factory (NASDAQ:RMCF), but as an investor, I'm more concerned with the composition of the board -- and the legal problems in their past. The board's dubious history includes a cease and desist order from the SEC for not reporting transactions in a timely manner. There's also a complaint by the director of insurance for Illinois, alleging that funds were transferred from insurance companies for personal use, which eventually left the insurance companies unable to pay claims. None of these items are directly attributable to Rocky Mountain Chocolate Factory or its operational management, but when a company's leadership team has items like this in its past, investors should take note.
The good guys
Happily, there are plenty of CEOs out there who simply want to do a good job and know that people are counting on them. Most of them may not get the attention that Warren Buffett and Berkshire Hathaway (NYSE:BRKa) (NYSE:BRKb) get, but they're out there.
These CEOs don't attract much attention because they're often at mundane companies with businesses that most people don't follow closely. Sadly, doing a job poorly draws headlines quickly, but doing a job well takes a few years to garner recognition. One example is Fastenal (NASDAQ:FAST), which sells nuts, bolts, and other assorted tools. It's no household name, but the company's pay packages aren't out of line, and management speaks candidly about the business and its prospects.
Foolish final thoughts
It's more than likely that the CEOs running the companies you invest in are going to have larger-than-average egos. In most cases, it's a healthy phenomenon; the kings of the past weren't all bad, and neither are CEOs. Nonetheless, investors should take the time to discover in which camp a CEO resides before buying shares. Too many investors ignore management's dramatic effect on returns until it's too late. You shouldn't be one of them.
Nathan Parmelee owns shares in Berkshire Hathaway and Kenneth Cole Productions but has no financial interest in any of the other companies mentioned. You can view his profile here. The Motley Fool has an ironclad disclosure policy.
