Tags: Bad | Management | Investments | Chesapeake

Bad Management Makes for Bad Investments

By    |   Tuesday, 08 May 2012 08:52 AM

Last month, a historic event occurred in the banking sector. Shareholders at Citigroup (C) voted to reign in the CEO’s salary. Despite the alleged excesses of the banking system, this is the first time that shareholders have specifically expressed outrage over the size and scope of executive pay.

But there’s one catch: The vote is advisory. It’s not binding. And while Citigroups’ board of directors will take it under advisement, they don’t have to change a thing.

In short, management can ignore the demands of shareholders.

Things aren’t supposed to work that way. On paper, it’s much different. Shareholders are the owners of a company. It’s their role to hire a board of directors, who, in turn, hire and oversee management.

In theory, this all sounds well and neat. In practice, it’s a mess. Why?

Because individuals typically aren’t the majority owners of a company. Rather, funds ranging from private equity to 401(k) plans to insurance and banking companies own shares of a company. They have dozens if not hundreds of companies to invest in, and don’t have the time to keep a close eye on a company.

Furthermore, higher trading and turnover means ownership is fluctuating daily. When owners change rapidly, only management becomes entrenched — and that’s not always good.

So, management and the board of directors have lost a key check. Even when they do have vocal shareholders, like in the case of Citigroup, it’s not normal. This disconnect between how corporate management is supposed to work and how it does work can lead to other excesses beyond company pay.

Consider the recent case of Chesapeake Energy (CHK). The company faces an informal inquiry by the SEC regarding its practices in enriching its CEO, Aubrey McClendon, at the expense of shareholders.

Specifically, the company has allowed McClendon to take a personal stake in each well the gas company has drilled. At various times it has also offered loans with sweetheart deals. The company even paid millions to buy McClendon’s multi-million dollar map collection!

These practices received little scrutiny when the company was expanding and nat gas prices were rising. But now that nat gas prices are at decade lows and the company faces major headwinds, it’s only natural to wonder why one person has been enriched at the expense of thousands of shareholders.

As investors, we must recognize that management is going to get some perks. But when those perks get extreme, it’s a sign that the company isn’t being run with the maximization of share price in mind.

Shares of Citigroup and Chesapeake Energy may rally. But if they do, it won’t be due to the competence of management. Unless you’re vying for a 10 percent stake and a seat on the board, it may be better to cash out and invest where management is more shareholder-friendly.

Fortunately, there are still plenty of companies run by owner-operators with major stock positions. If management isn’t looking out for your best interest, nobody is.

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Tuesday, 08 May 2012 08:52 AM
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