A few weeks ago, I wrote about the tussle in Japan between Livedoor and Fuji-Sankei group companies Fuji TV and Nippon Broadcasting. Livedoor, by purchasing over 35% of the shares of Nippon Broadcasting on the open market, had effectively taken control of Nippon Broadcasting and its 22.5% ownership stake in Fuji TV. It's a fascinating story taking place within Japanese business culture, and I have been very interested in the behavior of the various management teams. After all, as investors, we have to place a certain faith in management teams that have a direct impact on our returns.
As an aside, I'm delighted that the Japanese judicial system blocked Nippon Broadcasting's attempt to dilute the ownership stake of all its shareholders -- in order to thwart Livedoor's takeover -- by selling shares directly to Fuji TV, its fellow group company. What raised the hair on my neck about Nippon Broadcasting's plan was that by doubling its share count -- with all shares going to Fuji TV -- management telegraphed to shareholders that it couldn't care less about them and the value of their shares. Of course, it's important to keep in mind that this is the same company that saw its market cap fall below the value of its holdings in Fuji TV, so shareholder neglect had been in place for a while.
Shareholder neglect happens everywhere
Japan has a reputation for being shareholder-unfriendly, but this type of behavior is not exclusive to Japan. A few years ago, my Foolish colleague Bill Mann wrote a great piece about UK company WPP Group's (NASDAQ:WPPGY) proposal of a pay package that would have paid its CEO up to $160 million over three years. I'm all for people getting paid what they're worth, but I have a hard time swallowing the idea that WPP's chief should be paid more than my beloved Boston Red Sox.
Aside from the abuses at Enron, WorldCom, and Adelphia, one of the most egregious acts of stateside management showing a lack of interest in their shareholders goes to Intel (NASDAQ:INTC) CEO Craig Barrett. Last year, Mr. Barrett advertised to the world in TheWall Street Journal that options expensing was for the birds. He argued that options are a competitive advantage for the United States, and to reflect this cost in the financial statements takes away this competitive advantage. Aside from being disingenuous, this is just wrong. Options dilute the current owners of shares, and shares in a company absolutely have a value. In my opinion, options can be a good tool if used wisely, and the best way I can think of to measure their effectiveness is to count their cost. But all too often, they get used to line management's pockets, and not surprisingly, those folks don't want too much visibility here.
What motivates management?
As investors, I think we assume that management's first interest is in creating shareholder value. Even holders of options want to see the shares rise in value. Truth is, that's not always the case. A book that really drives home this point is Martin Whitman's Value Investing. The book discusses many of the motives that management may have besides increasing the value of shares. The most common of these is to get control and then take something off the top. That can take many forms, such as the options and salary packages discussed above, or even private jet rentals and purchases from related parties. The other day, while cruising around for undervalued stocks, I was looking at the registration filing for recently public Odimo (NASDAQ:ODMO), and given that the company is an online retailer of diamonds and high-value goods, I was surprised to see a reference to a jet-rental arrangement between the company and another inside shareholder. The jet may be needed to help run the business, but I'm always skeptical of such agreements.
Skin in the game
One very good way to find companies that are closer to the Berkshire Hathaway model of treating shareholders equally, and less like the Nippon Broadcasting model, is by looking for companies with operating managers who own shares. It's not a coincidence that many of Tom Gardner's picks in Motley Fool Hidden Gems have high insider ownership or that Warren Buffett and Charlie Munger own the lion's share of Berkshire. Operating managers, such as CEOs and CFOs, who have an ownership stake in the company, have a vested interest in taking care of the business. When they do well, you do well. Managers without an ownership stake are more likely to be in it for an expanding paycheck and more apt to be looking for ways to skim something off the top.
Inside ownership is not a cure-all for management abuses. There are exceptions to the rule above. On occasion, founders who still own more than 50% of the stock -- or own less but hold a second class of shares with super voting rights that don't trade publicly -- will also be more liberal with company funds and perks.
Check the past
Another excellent way to evaluate management is to compare two to three years' worth of the letters to shareholders found in annual reports and proxy statements. Did the company meet the goals targeted in the letter to shareholders? If not, did management still get a raise or a large bonus? Finding out does take a little bit of digging, but it's worth the trouble.
Final words
Evaluating management and its motives is not an easy task for investors. But by keeping an eye out for inside ownership and low levels of dilution, you improve your odds. And there's still something to be said for speaking plainly. If a company's structure or communications seem complicated or difficult to understand, it's often because it's not meant to be understood.
- Absurdity and Rationality in Omaha
- Singed by Shareholder Backlash
- The Importance of Insider Ownership
- Livedoor's Bid for Change in Japan
- 3 Rising Stars
- Options: The Choice of Californians and Crooks
Fool contributor NathanParmelee owns shares in Berkshire Hathaway. The Motley Fool has a disclosure policy.
