7 Signs of Shareholder Friendly Management

[Share Investor]

By Joshua Kennon, About.com

Good corporate governance is important for your portfolio. When you are in business with people who are interested in making sure you, the shareholder, get a fair shake, you are likely to have better results. Here are seven things you can look for in an owner-oriented enterprise.

1. Clearly Articulated Dividend Policy with Justifiable Rational
One of the most important jobs management has is to allocate shareholder capital. How excess profits are handled is extraordinarily important; whether reinvested in existing operations, used to acquire a competitor, expand into other industries, repurchase shares, or increase cash dividends to owners, the decision will have a substantial impact on the wealth of the owners. As Warren Buffett aptly illustrated in one of his shareholder letters , however, this is not something that comes naturally to most executives. “The lack of skill that many CEOs have at capital allocation is no small matter: After ten years on the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business.”

When management articulates a clear and justifiable dividend policy, shareholders are better able to hold them accountable and judge performance. It also tempers the urge to pursue overpriced acquisitions. An excellent example is U.S. Bank, the sixth largest financial institution in the world. According to the company’s 2005 annual report, “The Company has targeted returning 80 percent of earnings to our shareholders through a combination of dividends and share repurchases. In keeping with the target, the Company returned 90 percent of earnings in 2005.”

2. Management Stock Ownership Guidelines
All else being equal, you want your capital managed by someone who has “skin in the game”, so to speak. Shareholder friendly companies typically require their managers and executives to own stock in the company worth several times their base salary. This ensures that they are thinking primarily as owners, not employees.

3. Strong Directors That are Loyal to Shareholders, Not Management
The Board of Directors must know its primary job – to protect the interest of shareholders, not management. Throughout financial history, it seems that most corporate scandals have occurred when a board was too comfortable with the executive team. This phenomenon is understandable; when working with people you like and respect, it’s certainly easier to have friendly clubhouse atmosphere rather than an adversarial fight club.

How can you tell if the directors are on your side? Look for a few key signs:

* Independent directors hold meetings without management being present.
* Board compensation is reasonable and not excessive.

4. Equity and Voting Rights Aligned
In most cases, it is not a good sign for management to own 2% of the stock and yet control 80% of the voting power. These lopsided arrangements can lead to the kind of shareholder abuse that was alleged at Adelphia.

5. Limited Related-Party Transactions
Does the company lease all of its facilities from a real estate company owned and controlled by the family of the CEO? Are all of the napkins at your pizza chain purchased from the granddaughter of the founder? Although some related party transactions can actually be good for business, be aware of situations that could lead to conflicts of interest. Taking our last example: are shareholders going to get the lowest price possible on napkins, or is the CEO going to feel like helping out the granddaughter’s founder by paying more than he knows he could get elsewhere?

6. Limited and Reasonable Stock Options and Executive Compensation
If the CEO is paid $100 million, it may be perfectly justified if the company is among the top performers during his or her tenure. If business is down, talent is jumping ship, shareholders are revolting, and a massive pay package is announced, there may be very real corporate governance problems.

7. Open and Honest Communication
As an owner of the business, you have a right to know the challenges and opportunities that face your business. If management is reticent to share information, it may signal a tendency to view shareholders as a necessary evil instead of the true owners of the business. In most cases, your portfolio will be better off if you steer clear.