With literally thousands of public companies touting their prospects, it is a mathematical certainty that some are not telling the truth. Which management teams should investors trust? Who should be avoided? Is there a way to identify purposefully deceitful executives?
We believe that the quality of the jockey is often more important than quality of the horse. As a result, gauging the personality of a management team is an integral part of our investment process. We have historically favored the "quiet trumpets", that is executives committed to honestly assessing their business rather than cheer-leading their stock price. We are focused on finding passionate operators (not promoters) who are dedicated to capably executing a specific long term vision.
Making this determination is largely a subjective process that often depends on our "gut feel" (sometimes simply the absence of a slimy feeling) after meeting or speaking to a team directly. Admittedly, our batting average has not been 100%, and we occasionally are surprised to find out that we have misjudged a management team. However, we have had success avoiding trouble by applying a checklist of sorts that seeks to eliminate self interested or overly-promotional management teams. This list of "red flags" is pretty straight-forward and includes:
- Excessive compensation or perquisites (company paid jets, private clubs, etc.)
- Historical "Blow Ups" (Previous failures as public company executive)
- Nepotism (Executives & Board members who all share the same last name)
- Dual share structures (granting majority voting control to executives who own a minority of the shares)
- Questionable related party transactions or other evidence of self dealing
- Excessive wearing of Jewelry
- Location of the company (Typically avoid Miami, Las Vegas and Atlantic City)
As students of behavioral finance, we have long been interested in improving our process to identify deception and weed out poor management teams. We have enjoyed reading several recent studies which explore this topic in more detail and will discuss in subsequent posits:
- Detecting Deception on Conference Calls
- What we can learn from the prevalence of diving in Soccer matches
- Related Party Transactions and the incidence of fraud