The True Dangers of Risk

Investors who ignore the many manifestations of risk are making a huge mistake. Companies with poor corporate governance policies, and executives who indulge in selfish behavior, create a serious risk that shareholders too often overlook.

Some risks are more costly than others
As the recent, horrible tragedy at Massey Energy's (NYSE: MEE) West Virginia coal mine demonstrates, no one should have to tell corporate managers to place employees' safety and lives ahead of potential profits. CAPS blogger lemoneater recently asked whether investing in the coal miner was really worth it, noting the ethical red flags the company had raised. 

Massey had also racked up a shocking number of environmental and safety violations. Furthermore, investors who took enough time to research the company would have also found a Supreme Court ruling that Massey Chairman and CEO Don Blankenship's campaign contributions had influenced a West Virginia Supreme Court judge several years ago, creating a serious risk of bias.

Yesterday, the corporate governance watchdogs at The Corporate Library said they had long warned about some of Massey Energy's policies. Massey's CEO retention bonuses lacked performance targets, and in 2008, the company -- wait for it -- lowered the bar for other compensation-related performance targets. If you can't meet the standards, just bring them down to your level, right? Clearly, Massey gave investors ample reasons to steer clear of its stock.

Sure, your company's managers may seem harmless, and their failings insignificant, in the short run. What's a little self-serving behavior as long as they keep hauling in the profits? But by turning a blind eye, you might embolden executives to pursue far more unethical and damaging deeds. In Massey Energy's case, the company's dubious policies now endanger not only its investors' portfolios, but also their ability to sleep at night.

Same old risk, different day
In the wake of the financial crisis, Bank of America (NYSE: BAC), Goldman Sachs (NYSE: GS), Citigroup (NYSE: C), and their fellow financial firms should have more than earned investors' skepticism, at least until they proved their disaster-prone behavior was a thing of the past. Instead, their burgeoning stock prices over the past year suggest to me that investors are either incredibly naive, or just have really short attention spans.

Lo and behold, according to The Wall Street Journal, the Federal Reserve Bank of New York revealed that a group of 18 banks, including the ones named above, have been hiding debt for the last five quarters. They've temporarily lowered debt levels right before reporting to the SEC, then ratcheted it right back up by midquarter, making their balance sheets look more safe and sensible than they actually are. One suspects that the accounting infractions recently revealed at now-defunct Lehman Brothers weren't exactly an anomaly on Wall Street.

Wake up, suckers -- I mean, shareholders! By all appearances, these big banks remain more concerned with their own well-being than the honesty, transparency, and prudence of their businesses. I can't believe I'd ever even have to explain why that's not OK. Companies have a responsibility to be truthful with their shareholders, so that investors can properly assess the risk involved.

Trust: a major asset
If a corporation's managers give ample indication that they're only in it for themselves -- paying themselves handsomely for failure, or exhibiting dishonesty about real business concerns -- shareholders should brace for bad news. Executives' bad behavior is an intangible liability, however much it may generate in short-term paper gains.

Fortunately, good companies and managers do exist. Berkshire Hathaway's (NYSE: BRK-B) Warren Buffett hasn't done too badly for himself (to say the least!) by focusing on solid businesses with high-quality management teams. He has also been an outspoken critic of many abusive policies in corporate America, and he always seems to make honesty a strong point in his own dealings.

Harris Interactive's recent Reputation Quotient survey named Berkshire Hathaway one of America's most trusted companies. Not surprisingly, financial companies like Goldman, Citigroup, and AIG (NYSE: AIG) ranked among the least reputable, with Freddie Mac (NYSE: FRE) at the very bottom.

Truly sustainable long-term profits spring from real, hard-earned trust between managers and shareholders. If your company's leadership can't grasp that concept -- or exhibits reckless behavior -- it's up to you to recognize the danger.