You don't feel the presence of good management until it's gone
A die-hard fan of Ajit (the ultimate stereotype of the evil villain!) who was stung by the Satyam episode expressed it fairly succinctly: “Good management is a bit like oxygen—it’s invisible and you don’t notice its presence until it’s gone and then you’re sorry.” Beyond providing a strategic roadmap, motivating employees and allocating capital wisely, a great management team is charged with the responsibility of coming up trumps in an increasingly hostile operating environment. Most of what matters in investing has been summed up by elegant and comprehensive quantitative models. Yet, the ability to benchmark the quality of management remains stubbornly resistant to this formulaic approach.
Productivity and profitability analyses provide basic inputs about the capability of management. A historical trend analysis of asset utilisation, operating margins and capital efficiency (ROE/ROCE) relative to best in class competitors is a good starting point. While these are useful measures of “doing things right”, they are a trifle simplistic since the crux of assessing management is to fully comprehend their incentives and its degree of alignment with those of minority shareholders. The most important information to be gleaned is the quantum of shares held by senior managers. Minority shareholders would most definitely wish to see the stewards of their interest staking a large portion of their wealth to personal ownership of stock. More recently it has become essential for investors to scrutinise the stock option plans put forward by management as a way of bolstering their compensation. These long-term rights to acquire shares are often extremely valuable even though companies are not obligated to recognise the worth of these options by making an appropriate deduction from current earnings.
The doubt that most often creeps in is whether management might have acted differently if the parent did not have a large equity stake. Most often, public companies steadfastly maintain that little good would come about from greater investor involvement in these areas. In fact, most of them seek to actively discourage investor participation in corporate governance. Since individual investors are widely dispersed, they lack sufficient clout to engage management. Institutional investors typically have neither any incentive nor skill to get actively involved in unravelling these problems in the firms where they have substantial stakes. Voting proxies defines the limit of their concern and there is hardly any secret in how this process unfolds. The majority of money managers prefer to vote with their feet, by selling shares in companies they perceive as being ineffectually managed. It is noteworthy, however, that even if one were inclined to be activist, the existing security laws would pose significant obstacles in challenging incumbent management. The existence of well-established ‘public sector’ companies adds grist to the mill. It is hardly surprising that investors worry about government officials using their power to advocate corporate actions that either benefit a non-economic agenda or distort policy making. Buffett has repeatedly gone on record to state that efficient capital allocation is the only responsibility of the top management crew. Given the clear demarcation between ownership and control in publicly listed companies, the primacy of rational and disciplined capital allocation focussed on enhancing long-term shareholder value must be the ultimate yardstick of managerial success.
(This story appears in the 07 March, 2014 issue of Forbes India. To visit our Archives, click here.)