One of the factors we consider when looking at a company is how key decision makers are paid. It's no secret, people will tend to do what is in their best interest. This is no different for mutual fund managers. Nothing aligns a portfolio manager better with mutual fund unitholders than being a mutal fund unitholder.
A good amount of time has been spent looking at new ideas and right now many are in the U.S. Part of that work is diving into how the management teams at these companies are paid. While there is not a set list of criteria, here are some things to watch out for:
- Quantitative elements of compensation are tied to hitting challenging, but achievable targets tied to appropriate metrics (for this company it was return on capital and growth in earnings per share). It is important that these metrics do not just incentivize management to make the company bigger (revenue), but instead better (growth in value, per share). We have seen examples in the past of managers who were paid to grow; they did, unfortunately by making overpriced acquisitions.
- All members of the compensation committee are independent. In addition to being independent, it is important they have the fortitude to stand up to managers and make tough choices when necessary.
- All awards can be clawed back in the event of a future restatement or write down. This can help reduce the incentive to use aggressive accounting to hit short-term targets.
- The CEO does not have an employment, severance or golden parachute agreement with the company. This provides little protection in the event of poor performance. It is concerning to see agreements where a CEO will make a fortune irrespective of how the company performs.
- Senior managers being required to hold high levels of company stock. In this case it was 4-6x total compensation. The higher the ownership position relative to annual compensation, the more likely they are to think like an owner versus simply a manager.
While none of this is rocket science, it's often the simple things, which make the biggest difference over the long term. Few things are important as having management on your side.