The value of management in assessing investment quality

I have written already about the benefits of investing in “quality” stocks as long term investments, and also on why, at times, quality might be overvalued. But I have only briefly mentioned management as a component of this concept of “quality”.

There is no one way of assessing management quality, and metrics are more “soft” than quantitative. But many fund managers put substantial emphasis on management quality as a reason for (or for not) investing in a company, and the current G4S Olympic security debacle suggests that a focus on the quality of management is important.

Back towards the beginning of the year, I explained how G4S’s aborted attempt to take over ISS was an example of di-worsification. Unfortunately the news again forces G4S’s management into the spotlight: now over their last minute realisation that they could not meet the contract for security for the Olympic Games. At the time of writing, the chief executive’s position is certainly under scrutiny, and, unsurprisingly, G4S’s share price has fallen substantially – not only because of the immediate cost of this failure, but also on concerns over reputational damage. If there was ever a time when the adage that all publicity is good publicity does not hold, it is probably when public failure at the world’s largest sporting event garners constant media attention. In some ways, a not dissimilar situation surrounds Barclays – and quite possibly, over coming weeks and months, other banks. In the latter case, the departure of the chief executive and reputational damage again impedes the share price and so hurts investors.

So, what is the role of management, and can we, as investors, foresee potential problems and/or avoid them by being biased to “quality” management (if, indeed, such a thing exists). While there is not a single definition of “quality” management, some combination of a demonstrable track record, relevant experience and alignment of incentives is a good starting point. The latter is probably the most headline-grabbing characteristic – chief executive pay attracts substantial media scrutiny, although the issue/problem here is that the focus is often on the amount, not its time horizon, structure, or success criteria. These are of far more importance than whether or not the total package is excessive – and in particular, creating short term incentives for management can, and often is, deleterious for long term value creation within a business.

We also need to differentiate our assessment of management based on company size. A smaller business will – generally – be simpler, have fewer employees, and probably will be less geographically dispersed. This makes oversight by a chief executive far simpler – and so a “good” chief executive should be a significant factor in the success of the business. More importantly, a single person can often be held to account for events in the company. Conversely, with larger and more complicated businesses, with significant multi-national operations and often different business segments, a single person, however capable, cannot have full oversight and so a substantial and multi-layered management team is essential. In this case, the chief executive is more of an overseer and strategy setter, and less able to either implement or monitor across all aspects of the business.